Exam 18: Ipos, Investment Banking, and Financial Restructuring

If its managers make a tender offer and buy all shares that were not held by the management team, this is called a private placement.

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

Europa Corporation is financing an ongoing construction project. The firm will need $5,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years, when the project has been completed. Debt flotation costs for a single debt issue would be 1.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.0% of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?

The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

Rainier Bros. has 12.0% semiannual coupon bonds outstanding that mature in 10 years. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?

Tuttle Buildings Inc. has decided to go public by selling $5,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (6% of gross proceeds versus their normal 10%) in exchange for a 1 year option to purchase an additional 200,000 shares at $5.00 per share. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12.00 per share one year from now. If the $12 price occurs, what would the present value of the entire underwriting compensation be? Assume that the investment banker's required return on such arrangements is 15%, and ignore taxes.

Going public establishes a market value for the firm's stock, and it also ensures that a liquid market will continue to exist for the firm's shares. This is especially true for small firms that are not widely followed by security analysts.