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Exam 14: Initial Public Offerings, Investment Banking, and Financial Restructuring

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Question 1

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An entrepreneur first started his business with $100,000. Later, a venture capitalist (VC) agrees to invest $300,000 to sustain the growth. In return, this VC will take up a 50% equity position in the firm. How much is this business worth now?

A) $400,000
B) $600,000
C) $700,000
D) $800,000

E) A) and B)
F) A) and C)

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Question 2

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Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then, long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

A) True
B) False

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Question 3

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What can underwriters likely do for new IPO issues with uncertain market demand from investors?

Scenario: ABC Waste ABC Waste (ABCW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 8.4% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. ABCW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to Scenario: ABC Waste. What is the NPV if ABCW refunds its bonds today?

Which statement concerning bought deals is true?

The TSX Exchange operates as a junior stock market, whereas TSX Venture Exchange trades senior equities.

Which of the following projects is more likely to be funded with project financing by investors?

In an IPO issue, the issuing company has incurred $10 million for the floatation costs and legal fees. The issue involves 50 million shares. As a firm commitment written deal, the underwriter agrees to buy the shares at $18 each and resells to the public at $20 per share. What will be the percentage of direct costs required in this deal?

The cost of filing reports with various regulatory bodies, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

Which of the following statements best describes listing on a stock exchange?

If its managers make a tender offer buying up all shares not held by the management team, this is called a private placement.

Which statement about equity carve-outs is true?

Which of the following is NOT included in flotation costs of an IPO?

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 1 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 1 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.

Scenario: ABC Waste ABC Waste (ABCW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 8.4% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. ABCW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to Scenario: ABC Waste. What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.

An equity carve-out is not only a spin-off but also a special type of IPO.

Which statement regarding the Canadian securities industry is true?

With a firm commitment underwriting, an investment bank agrees to sell 2 million shares to the public at $10 per share with a spread of $1. How much does the issuing company receive if only 1.5 million shares are sold?

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"?