MBA
International Finance
PRACTICE PROBLEMS (TUTORIAL)
How Companies Issue Securities
SKEMA
Professor Michael Graham
MBA 09/01/2019
Questions 2
a. Investors indicate to the underwriter
Each of the following terms how many shares they would like to
buy in a new issue and these
is associated with one of the indications are used to help set the
price.
events beneath. Can you b. The underwriter accepts responsibility
only to try to sell the issue.
match them up? c. Some issues are not registered but
can be traded freely among qualified
1. Best efforts institutional buyers.
d. Several tranches of the same security
2. Bookbuilding may be sold under the same
registration. (A “tranche” is a batch, a
3. Shelf registration fraction of a larger issue.)
MBA 09/01/2019 2
Questions 2
Best efforts: Underwriters agree to sell as much of a. Investors indicate to the underwriter how
many shares they would like to buy in a new
the issue as possible but do not guarantee the
issue and these indications are used to help
sale of the entire issue
set the price.
Bookbuilding: Underwriter attempts to sets a price
b. The underwriter accepts responsibility only
for IPO by recording investor demand, thereby to try to sell the issue.
determining the minimum price needed to sell all c. Some issues are not registered but can be
of the shares. traded freely among qualified institutional
buyers.
Shelf registration: A procedure that allows firms to
d. Several tranches of the same security may
file one registration statement for several issues
be sold under the same registration. (A
of the same security. Register financial plans for
“tranche” is a batch, a fraction of a larger
the future issue.)
MBA 09/01/2019 3
Questions 3
Explain what each of the following 3. Underwriting spread
terms or phrases means: The difference between the offer
price and the price paid to the
1. Venture capital
issuer
Financing of start-up companies
4. Registration statement
2. Bookbuilding Description of a security offering
Underwriters gather nonbinding filed with the regulator
indications of demand for a new 5. Winner's curse
issue Winning bidders for a new issue
tend to overpay
MBA 09/01/2019 4
Question 5
True or false? False. First stage financing is normally
Venture capitalists typically provide first-stage provided by family funds and bank loans.
financing sufficient to cover all development Second, stage financing is sometimes
expenses. Second-stage financing is provided by provided by angel investors or venture
stock issued in an IPO. capital firms, but venture capital firms
Underpricing in an IPO is only a problem when the rarely provide funding for all development
original investors are selling part of their holdings. expenses up front.
Stock price generally falls when the company Rather, they provide funding on a stage-
announces a new issue of shares. This is by-stage basis. Very few companies will
attributable to the information released by the
continue on to the phase of issuing an IPO
decision to issue.
to raise funds.
MBA 09/01/2019 5
Question 5
True or false? False. Underpricing can happen for various
reasons.
Venture capitalists typically provide first-stage
financing sufficient to cover all development 1. It is very difficult to judge how much investors
will be willing to pay for a stock.
expenses. Second-stage financing is provided by
stock issued in an IPO. 2. Some investment bankers say that underpricing
raises the price when it is subsequently traded
Underpricing in an IPO is only a problem when the
on the market, thereby making it easier for the
original investors are selling part of their holdings.
firm to raise further capital.
Stock price generally falls when the company
3. Third, is the concept of the winner’s curse—the
announces a new issue of shares. This is
knowledge on the part of the highest bidder that
attributable to the information released by the
he or she may have overpaid and adjusts his or
decision to issue. TRUE
her price down correspondingly
MBA 09/01/2019 6
Question 7
Associated Breweries is planning to market alcohol-free beer. To finance the venture it proposes
to make a rights issue at $10 of one new share for each two shares held. (The company currently
has outstanding 100,000 shares priced at $40 a share.) Assuming that the new money is invested
to earn a fair return, give values for the following:
a. Number of new shares.
b. Amount of new investment.
c. Total value of company after issue.
d. Total number of shares after issue.
e. Stock price after the issue.
f. The rights issue will give the shareholder the opportunity to buy one new share for less than the
market price. What is the value of this opportunity?
MBA 09/01/2019 7
Question 7
Associated Breweries is planning to market alcohol-free beer. To finance the venture it proposes
to make a rights issue at $10 of one new share for each two shares held. (The company
currently has outstanding 100,000 shares priced at $40 a share.) Assuming that the new money
is invested to earn a fair return, give values for the following:
Number of new shares
Number of new shares = existing shares / number of new shares per existing share
Number of new shares = 100,000 / 2 = 50,000
Amount of new investment
New investment = number of new shares × offer price per share
New investment = 50,000 × $10 = $500,000
MBA 09/01/2019 8
Question 7
Associated Breweries is planning to market alcohol-free beer. To finance the venture it proposes
to make a rights issue at $10 of one new share for each two shares held. (The company
currently has outstanding 100,000 shares priced at $40 a share.) Assuming that the new money
is invested to earn a fair return, give values for the following:
Total value of company after issue.
After-issue company value = existing value + new investment
After-issue company value = (100,000 × $40) + $500,000)
After-issue company value = $4,500,000
Total number of shares after issue
After-issue number of shares = existing shares + new shares
After-issue number of shares = 100,000 + 50,000
After-issue number of shares = 150,000
MBA 09/01/2019 9
Question 7
Associated Breweries is planning to market alcohol-free beer. To finance the venture it proposes
to make a rights issue at $10 of one new share for each two shares held. (The company
currently has outstanding 100,000 shares priced at $40 a share.) Assuming that the new money
is invested to earn a fair return, give values for the following:
Stock price after the issue (2 WAYS)
(1) After-issue stock price = after-issue company value / after-issue number of shares
After-issue stock price = $4,500,000 / 150,000 = $30
(2) After-issue stock price = [(number of shares required to obtain one right × stock price) + offer price per
one new share] / after-issue number of shares
After-issue stock price = [(2 × $40) + $10] / 3
After-issue stock price = $30
MBA 09/01/2019 10
Question 7
Associated Breweries is planning to market alcohol-free beer. To finance the venture it proposes
to make a rights issue at $10 of one new share for each two shares held. (The company
currently has outstanding 100,000 shares priced at $40 a share.) Assuming that the new money
is invested to earn a fair return, give values for the following:
The rights issue will give the shareholder the opportunity to buy one new share for
less than the market price. What is the value of this opportunity?
After-issue stock price – rights issue price
Opportunity value = $30 − $10
Opportunity value = $20
MBA 09/01/2019 11
Question 11
Why are the costs of debt issues less than those of
equity issues? List the possible reasons.
There are several possible reasons why the issue costs for debt are lower
than those of equity, among them:
1. The cost of complying with government regulations may be lower for
debt.
2. The risk of the security is less for debt and hence the price is less
volatile. This decreases the probability that the issue will be mispriced
and therefore decreases the underwriter’s risk.
MBA 09/01/2019 12
Question 14
• In 2012, the Pandora Box Company made a rights issue at €5 a
share of one new share for every four shares held. Before the
issue there were 10 million shares outstanding and the share
price was €6.
a. What was the total amount of new money raised?
b. What was the prospective stock price after the issue?
c. How far could the total value of the company fall before
shareholders would be unwilling to take up their rights?
MBA 09/01/2019 13
Question 14
Number of new shares = existing
• In 2012, the Pandora Box Company
shares / number of new shares per
made a rights issue at €5 a share of
existing share
one new share for every four shares
Number of new shares = 10,000,000 /
held. Before the issue there were 10
4
million shares outstanding and the
Number of new shares = 2,500,000
share price was €6.
New investment = number of new
What was the total amount of shares × offer price per share
new money raised? New investment = 2,500,000 × €5 =
€12,500,000
MBA 09/01/2019 14
Question 14
After-issue stock price = after- issue company
In 2012, the Pandora Box Company
value / after-issue shares
made a rights issue at €5 a share
= [(10,000,000 × €6) + €12,500,000] /
of one new share for every four (10,000,000 + 2,500,000) = €5.80
shares held. Before the issue there A stockholder who previously owned 4 shares had
stocks with a value of: (4 €6) = €24.
were 10 million shares outstanding
This stockholder has now paid €5 for a fifth share
and the share price was €6.
so that the total value is: (€24 + €5) = €29.
What was the prospective This stockholder now owns five shares with a value
stock price after the issue? of: (5 €5.80) = €29, so that she is no better or
worse off than she was before.
MBA 09/01/2019 15
Question 14
• In 2012, the Pandora Box Company The share price would have
made a rights issue at €5 a share of one
to fall to the issue price per
new share for every four shares held.
Before the issue there were 10 million share, or €5 per share. Firm
shares outstanding and the share price value would then be:
was €6.
Firm value = 10 million €5
How far could the total value of the
company fall before shareholders Firm value = €50.00 million
would be unwilling to take up their
rights?
MBA 09/01/2019 16
Question 17
Suppose that in April 2019 Van Dyck Exponents offered 100 shares for sale in an
IPO. Half of the shares were sold by the company and the other half by existing
shareholders, each of whom sold exactly half of their existing holding. The offering
price to the public was $50 and the underwriters received a spread of 7%. The
issue was heavily oversubscribed and on the first day of trading the stock price
rose to $160.
a. What were the proceeds of the issue to the company? To the shareholders?
b. How much commission did the underwriters receive?
c. How much money was left on the table?
d. What was the cost of the underpricing to the selling shareholders?
MBA 09/01/2019 17
Question 17
• Suppose that in April 2019 Van Dyck Exponents Issue proceeds to company = number of
offered 100 shares for sale in an IPO. Half of the shares × net price
shares were sold by the company and the other
Issue proceeds to company = (100 × .50)
half by existing shareholders, each of whom
sold exactly half of their existing holding. The × $50 × (1 – .07) = $2,325
offering price to the public was $50 and the
underwriters received a spread of 7%. The issue
Issue proceeds to shareholders = number
was heavily oversubscribed and on the first day
of trading the stock price rose to $160.
of shares × net price
a. What were the proceeds of the issue to
Issue proceeds to shareholders = (100
the company? To the shareholders? × .50) × $50 × (1 – .07)
Issue proceeds to shareholders = $2,325
MBA 09/01/2019 18
Question 17
• Suppose that in April 2019 Van Dyck Exponents
Commission = number
offered 100 shares for sale in an IPO. Half of the
shares were sold by the company and the other of shares × offer price
half by existing shareholders, each of whom
sold exactly half of their existing holding. The × commission rate
offering price to the public was $50 and the
Commission = 100 ×
underwriters received a spread of 7%. The issue
was heavily oversubscribed and on the first day $50 × .07
of trading the stock price rose to $160.
a. How much commission did the
Commission = $350
underwriters receive?
MBA 09/01/2019 19
Question 17
• Suppose that in April 2019 Van Dyck Exponents
Money left on table =
offered 100 shares for sale in an IPO. Half of the
shares were sold by the company and the other number of shares × (end of
half by existing shareholders, each of whom
day price – offer price)
sold exactly half of their existing holding. The
offering price to the public was $50 and the Money left on table = 100 ×
underwriters received a spread of 7%. The issue
was heavily oversubscribed and on the first day
($160 – 50)
of trading the stock price rose to $160. Money left on table =
a. How much money was left on the table?
$11,000
MBA 09/01/2019 20
Question 17
• Suppose that in April 2019 Van Dyck Selling shareholders’ cost = number of shares
Exponents offered 100 shares for sale in an × (end of day price – net price)
IPO. Half of the shares were sold by the Selling shareholders’ cost = (100 × .50) ×
company and the other half by existing {$160 – [$50 × (1– .07)]} = $5,675
shareholders, each of whom sold exactly half
of their existing holding. The offering price to
This can also be computed as:
the public was $50 and the underwriters
Selling shareholders’ cost = Percent of shares
received a spread of 7%. The issue was
heavily oversubscribed and on the first day of sold × (commission + money left on table)
trading the stock price rose to $160. Selling shareholders’ cost = .50 × ($350 +
11,000)
a. What was the cost of the underpricing
to the selling shareholders? Selling shareholders’ cost = $5,675
MBA 09/01/2019 21
Question 20
a. Why do venture capital (VC) companies prefer to advance money in stages? If
you were an entrepreneur, would you have been happy with such an
arrangement? With the benefit of hindsight would the VC gain or lose by
advancing money in stages?
b. The price at which the VC would invest more money in the entrepreneur was not
fixed in advance. But the entrepreneur could have given the VC an option to buy
more shares at a preset price. Would this have been better?
c. At the second stage financing the entrepreneur could have tried to raise money
from another venture capital company in preference to the current VC. To protect
themselves against this, venture capital firms sometimes demand first refusal on
new capital issues. Would you recommend this arrangement?
MBA 09/01/2019 22
Question 20
a. Why do venture capital Venture capital companies prefer to
advance money in stages because this
companies prefer to advance
approach provides an incentive for the
money in stages? If you were an
entrepreneur to reach the next stage, and it
entrepreneur, would you have allows the VC to check at each stage
been happy with such an whether the project continues to have a
arrangement? With the benefit of positive NPV.
hindsight would the VC gain or The entrepreneur is happy because it
signals their confidence.
lose by advancing money in
With hindsight, the VC loses because it has
stages?
to pay more for the shares at each stage.
MBA 09/01/2019 23
First-stage Financing
Receive first-stage financing if investors (VCs) are impressed
Prepare a
Obtained 50% of the business plus board representation business
plan
Equivalent to 1 million shares @ R1 each
Preferred stock that converts automatically into common stock
when and if new business succeeded in an initial public offering Receive
first-stage
or consistently generated more than a target level of earnings financing
First Stage Financing Statement of Financial Position (Market Value)
Cash from New Equity R1 000 000 New Equity from Venture Capital R1 000 000 Receive
subsequent
Other Assets (including intangibles) R1 000 000 Original Equity Held by Entrepreneur (s) R1 000 000 staged
financing
Value R2 000 000 Value R2 000 000
MBA 09/01/2019 24
Venture Capital
First Stage Financing Statement of Financial Position (Market Value)
Cash from New Equity R4 000 000 New Equity, second stage R4 000 000 Prepare a
Fixed Assets R1 000 000 Equity, first stage R5 000 000 business
Other Assets (including intangibles) R9 000 000 Original Equity Held by Entrepreneur (s) R5 000 000 plan
Value R14 000 000 Value R14 000 000
Receive
The after-the-money valuation is R14 million. first-stage
financing
The original investors marked up its original
investment to R5 million Receive
subsequent
The entrepreneur also noted an additional staged
financing
R4 million gain.
MBA 09/01/2019 25
Question 20
a. The price at which the VC The problem with this
would invest more money in arrangement would be that,
the entrepreneur was not fixed while the entrepreneur would
in advance. But the
have an incentive to ensure
entrepreneur could have given
that the option was exercised,
the VC an option to buy more
it would not have the incentive
shares at a preset price. Would
to maximize the price at which
this have been better?
it sells the new shares.
MBA 09/01/2019 26
Question 20
a. At the second stage financing the The right of first refusal could
entrepreneur could have tried to make sense if the VC was
raise money from another venture making a large up-front
capital company in preference to
investment that it needed to be
the current VC. To protect
able to recapture in its
themselves against this, venture
subsequent investments.
capital firms sometimes demand
first refusal on new capital issues.
In practice, the entrepreneur is
Would you recommend this likely to get the best deal from
arrangement? the VC.
MBA 09/01/2019 27
Questions &
Discussions
Session 1 Time Value of Money MBA 09/01/2019 28
