CH15

Fundamentals of Corporate Finance + Standard & Poor's Educational Version of Market Insight

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CHAPTER 15 How Corporations Issue Securities Answers to Practice Questions 1. a. Zero-stage financing represents the savings and personal loans the company’s principals raise to start a firm. First-stage and second-stage financing comes from funds provided by others (often venture capitalists) to supplement the founders’ investment. b. An after-the-money valuation represents the estimated value of the firm after the first-stage financing has been received. c. Mezzanine financing comes from other investors, after the financing provided by venture capitalists. d. A road show is a presentation about the firm given to potential investors in order to gauge their reactions to a stock issue and to estimate the demand for the new shares. e. A best efforts offer is an underwriter’s promise to sell as much as possible of a security issue. f. A qualified institutional buyer is a large financial institution which, under SEC Rule 144A, is allowed to trade unregistered securities with other qualified institutional buyers. g. Blue-sky laws are state laws governing the sale of securities within the state. 2. a. Management’s willingness to invest in Marvin’s equity was a credible signal because the management team stood to lose everything if the new venture failed, and thus they signaled their seriousness. By accepting only part of the venture capital that would be needed, management was increasing its own risk and reducing that of First Meriam. This decision would be costly and foolish if Marvin’s management team lacked confidence that the project would get past the first stage. b. Marvin’s management agreed not to accept lavish salaries. The cost of management perks comes out of the shareholders’ pockets. In Marvin’s case, the managers are the shareholders. 135
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3. Alternative procedures for initial public offerings of common stock include: a. Firm commitment underwriting in which the investment bankers buy the entire issue before reselling it to the public. The issuing company receives the money immediately, but at a price below the offering price. b. Best efforts offers in which the investment banker tries to sell as much of the issue as possible. The share price is higher but the entire issue may not be sold. c. In some countries, the issue may be auctioned off. In these cases, the firm may place a reserve (i.e., lowest acceptable) price, but both price and the number of shares sold are not known in advance.
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CH15 - CHAPTER 15 How Corporations Issue Securities Answers...

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