Q&A

2. Stock Offerings What is the danger of issuing too much stock? What is the role of the
securities firm that serves as the underwriter, and how can it ensure that the firm does not issue
too much stock?
The issuance of too much stock can cause dilution of ownership, and can depress stock prices
(reduce value) because the supply of stock may now exceed demand.
Securities firms distribute or place stock for corporations  advise (amt, price). They serve as
intermediaries since corporations issuing stock typically do not have the expertise to place their
own stock. They have experience to know how much stock can be digested by the market.

3. IPOs Why do firms engage in IPOs? What is the amount of the fees that the lead underwriter
and its syndicate charge a firm that is going public? Why are there many IPOs in some periods
and few IPOs in other periods?
Firms engage in IPOs when they have feasible expansion (raise funds) plans but are already near
their debt capacity
Private equity firms  IPO (raise funds)  Public equity firm
- Angle
- VC
- Private equity firms
- Hedge firms
Owners/ Investors  cash out

The transaction cost (fees) is normally about 7% of the gross proceeds received by the issuing
firm.
Firms prefer to engage in IPOs when business conditions and market conditions are favorable 
market confidence higher. They avoid IPOs if business conditions are poor, because they do not
need funds to expand if the business outlook is poor. Also, when business conditions are poor,
the market conditions are weak, meaning that they would have to sell their shares at a low price.

4. Venture Capital Explain the difference between obtaining funds from a venture capital firm
and engaging in an IPO. Explain how the IPO may serve as a means by which the venture capital
firm can cash out
Before a firm engages in an IPO, it may obtain equity funding from a venture capital firm for a
period of two to five years. An IPO allows other shareholders to invest in the equity of the firm.
Venture capital firms tend to sell off their shares shortly after the firm engages in an IPO. After
the shares are publicly traded, the venture capital firm may sell its shares in the secondary
market.

11. Asymmetric Information Discuss the concept of asymmetric information. Explain why it
may motivate firms to repurchase some of their stock
Asymmetric information may allow a firm's managers to realize when its stock is undervalued,
and they may repurchase shares at that time.

PCP
Should a Stock Exchange Enforce Some Governance Standards on the Firms Listed
on the Exchange?
Point No. Governance is the responsibility of the firms, not the stock exchange. The stock
exchange should simply ensure that the trading rules of the exchange are enforced and should not
intervene in the firms’ governance issues
Counter-Point Yes. By enforcing governance standards such as requiring a listed firm to have a
majority of outside members on its board of directors, a stock exchange can enhance its own
credibility
Who Is Correct? Use the Internet to learn more about this issue and then formulate your own
opinion.

FOF
Contemplating an Initial Public Offering
Recall that if the economy continues to be strong, Carson Company may need to increase its
production capacity by about 50 percent over the next few years to satisfy demand. It would need
financing to expand and accommodate the increase in production. Recall that the yield curve is
currently upward sloping. Also recall that Carson is concerned about a possible slowing of the
economy because of potential Fed actions to reduce inflation. It is also considering issuing stock
or bonds to raise funds in the next year
a. If Carson issued stock now, it would have the flexibility to obtain more debt and would
also be able to reduce its cost of financing with debt. Why?
If Carson supports some of its growth with stock, it changes its capital structure to
include more equity that does not require a cash outflow (no interest payments). Thus, it
can more easily cover its debt payments. In addition, financial institutions would be more
willing to provide more credit because Carson has more equity to support its business and
is less likely to default on debt.

b. Why would an IPO result in heightened concerns in financial markets about Carson
Company’s potential agency problems?
When the firm is publicly owned, management is at least partially separated from
ownership. Managers are agents who are supposed to be serving shareholder interests.
Yet, the managers may be tempted to make decisions that are in their own best interests
rather than maximize shareholder wealth. If there are agency problems, the firm’s
performance may suffer, and its stock price would be reduced. Shareholders who own
stock are adversely affected by agency problems.

c. Explain why institutional investors, such as mutual funds and pension funds, that invest
in stock for long-term periods (at least a year or two) might prefer to invest in IPOs rather
than to purchase other stocks that have been publicly traded for several years.
Institutional investors may believe that the market does not properly price newly issued
stock, and they can capitalize on this discrepancy by investing in IPOs.
Problems
1. Buying on Margin Assume that Vogl stock is priced at $50 per share and pays a dividend of
$1 per share. An investor purchases the stock on margin, paying $30 per share and borrowing the
remainder from the brokerage firm at 10 percent annualized interest. If, after one year, the stock
is sold at a price of $60 per share, what is the return to the investor?
R = (SP – INV – LOAN + D)/INV
= (60 – 30 – 22 + 1) / (30) = 30%

3. Buying on Margin Suppose that you buy a stock for $48 by paying $25 and borrowing the
remaining $23 from a brokerage firm at 8 percent annualized interest. The stock pays an annual
dividend of $0.80 per share, and after one year you are able to sell it for $65. Calculate your
return on the stock. Then, calculate the return on the stock if you had used only personal funds to
make the purchase. Repeat the problem assuming that only personal funds are used and that you
are able to sell the stock at $40 at the end of one year.
R = (SP – INV – LOAN + D)/INV = (65 – 25 – 24.84 + 0.8)/25 = 63.84%

Only personal funds  did not use any borrowed funds when purchasing the stock
R = (65 – 48 – 0 + 0.8)/48 = 37.1%

Selling price at $40