# If it is easier for you to consider a probability use

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scenarios is not relevant for the exercise. If it is easier for you to consider a probability, use a 50% probability for each of the possible outcomes). Suppose that there are no taxes, and after paying any interest on debt, both companies use all remaining free cash flows to pay dividends each year. 1. Write a table showing the payments debt and equity holders of each firm will receive given each of the two possible levels of free cash flows: (10 marks) 2. Suppose you own 10% of the equity of Without (Firm A). What other portfolio could you hold that would provide you with the same exact cash flows? (5 marks) 3. Suppose you own 10% of the equity of With (Firm B). What other portfolio could you hold that would provide you with the same exact cash flows? (10 marks) 4. Briefly discuss why the homemade scenario presented in question 3 would not be possible to reach by the investor if the company had access to a cheaper source of debt than him. (5 marks) III. OPTION C IPO PUZZLES Use the following information to answer the question(s) below. Wyatt Oil has 8 million shares outstanding and is about to issue 10 million new shares in an IPO. The IPO price has been set at £15 per share, and the underwriting spread is 6%. The IPO is a big success with investors, and the share price rises to £35 the first day of trading. 1. How much did Wyatt Oil raise during the IPO? (5 marks) 2. What is the market value of Wyatt Oil after the IPO? (10 marks) 3. Suppose that the post IPO value of Wyatt is its fair market value. Suppose Wyatt could have issued shares directly to investors at their fair market value, in a perfect market with no underwriting spread and no underpricing. What would be the share price if Wyatt raises the same amount of funds that it would have with the investment banker handling the underwriting? (10 marks) 4. Briefly discuss how this underpriced IPO affects pre-IPO shareholders. Why would they agree to bear the costs of this underpricing? (5 marks)

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