BFC3140 Corporate Finance 2 Week 05
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BFC3140 Corporate Finance 2
Week 05 Tutorial Answers: Equity Finance (Chapter 23)
23-1. What are some of the alternative sources from which private companies can raise equity capital?
Private companies can raise equity capital from angel investors, venture capitalists, institutional investors, or corporate investors.
23-5. Three years ago, you founded your own company. You invested $120,000 of your money and received
6 million shares of Series A preferred stock. Since then, your company has been through three additional rounds of financing.
Round Price ($) Number of Shares
|
Series B |
0.60 |
1,000,000 |
|
Series C |
3.50 |
500,000 |
|
Series D |
4.00 |
550,000 |
a. What is the pre-money valuation for the Series D funding round?
b. What is the post-money valuation for the Series D funding round?
c. Assuming that you own only the Series A preferred stock (and that each share of all series of preferred stock is convertible into one share of common stock), what percentage of the firm do you own after the last funding round?
a. Before the Series D funding round, there are (6,000,000 + 1,000,000 + 500,000) = 7,500,000 shares outstanding. Given a Series D funding price of $4.00 per share, the pre-money valuation is (7,500,000) ×$4.00/share = $30.0 million.
b. After the funding round, there will be (7,500,000 + 550,000 = 8,050,000) shares outstanding, so the post- money valuation is (8,050,000) ×$4.00/share = $32.2 million.
c. You will own 6,000,000 / 8,050,000 = 74.5% of the firm after the last funding round.
23-11. Roundtree Software is going public using an auction IPO. The firm has received the following bids:
Price ($) Number of Shares
|
14.40 |
120,000 |
|
14.20 |
200,000 |
|
14.00 |
540,000 |
|
13.80 |
1,200,000 |
|
13.60 |
1,200,000 |
|
13.40 |
800,000 |
|
13.20 |
400,000 |
Assuming Roundtree would like to sell 2.06 million shares in its IPO, what will the winning auction offer price be?
First, compute the cumulative total number of shares demanded at or above any given price:
Price Cumulative Demand
14.40
14.20
14.00
13.80
13.60
13.40
120,000
320,000
860,000
2,060,000
3,260,000
4,060,000
13.20
4,460,000
The winning price should be $13.80, because investors have placed orders for a total of 2.06 million shares at a price of $13.80 or higher.
23-14. Margoles Publishing recently completed its IPO. The stock was offered at a price of $14 per share. On
the first day of trading, the stock closed at $19 per share. What was the initial return on Margoles? Who benefited from this underpricing? Who lost, and why?
The initial return on Margoles Publishing stock is ($19.00 - $14.00) / ($14.00) = 35.7%.
Who gains from the price increase? Investors who were able to buy at the IPO price of $14/share see an immediate return of 35.7% on their investment.
To the extent that the investors who were able to obtain shares in the IPO have other relationships with the investment banks, the investment banks may benefit indirectly from the deal through their future business with these customers.
Owners of the other shares outstanding that were not sold as part of the IPO see their shares valued at $19 but do not benefit from the underpricing per se (assuming that the price after the first day of trading does not depend on the initial price).
Who loses from the price increase? The original shareholders who offered their stock in the IPO lose, because they sold the stock for $14.00 per share when the market was willing to pay $19.00 per share (however, it is fair to say that ex-post they lose but ex-ante they do not, because they either expected $14 to be a fair price or they viewed the underpricing as a cost they were willing to pay in exchange for liquidity).
|
23-20. |
MacKenzie Corporation currently has 11 million shares of stock outstanding at a price of $43 per share. The company would like to raise money and has announced a rights issue. Every existing shareholder will be sent one right per share of stock that he or she owns. The company plans to require five rights to purchase one share at a price of $43 per share. a. Assuming the rights issue is successful, how much money will it raise? b. What will the share price be after the rights issue? (Assume perfect capital markets.) Suppose instead that the firm changes the plan so that each right gives the holder the right to purchase one share at $6 per share. c. How much money will the new plan raise? d. What will the share price be after the rights issue? e. Which plan is better for the firm’s shareholders? Which is more likely to raise the full amount of capital? a. 11m shares/5 x $43 = $94.6 million b. Total shares = 11 + 11/5 = 13.2m Value = $43 x $11 million + $94.6 million in new capital = $567.6 million Share price = 557.6/13.2 = $43 (note that it is the same as the original price, since the stock was fairly priced) c. 11mx $6 = $66 million d. Total shares = 11 + 11 = 22m |
Value = $43 x 11 million + $66 million in new capital = $539
Share price = 539 / 22 = $24.5
e. The firm is raising different amounts, so if both are fully subscribed, the firm’s use of the cash will determine in which case they are better off. Absent this factor (or if the first case is undersubscribed and the firm raises only $66m), shareholders are indifferent.
However, the second plan is much more likely to be fully subscribed, because exercising the right is a good deal. In the first case, shareholders are indifferent between exercising and not exercising.
In the first case, each share is worth $43, and exercising the right has 0 NPV, so the total value of a share is $43.
In the second case, the share is worth $24.5, but the right is worth (24.5 – 6) = $18.5, so the total value from owning a share is $24.5 + $18.5 = $43 per share. If shareholders do not exercise the right, they lose the $18.5.
2023-08-28
Tutorial Answers: Equity Finance