Test bank corporate finance 8e ros chap016

Chapter 016 Raising Capital Multiple Choice Questions What is venture capital? a equity funds from internal sources used to finance high-risk projects b capital raised from issuing equity securities in order to retire debt securities C financing for new firms which generally entails high levels of risk d bank loans used to pay the start-up costs of a new firm e the use of supplier credit as a means of financing the initial inventory purchases of a new firm SECTION: 16.1 TOPIC: VENTURE CAPITAL TYPE: DEFINITIONS A form filed with the SEC that discloses all material information related to a public offering is called a(n): a offering prospectus b red herring filing c indenture contract d public release statement E registration statement SECTION: 16.2 TOPIC: REGISTRATION STATEMENT TYPE: DEFINITIONS The SEC regulation that exempts public issues of less than $5 million from most registration requirements is called: a the Green Shoe Provision b the Red Herring Provision C Regulation A d Regulation Q e the Daily Business Exemption SECTION: 16.2 TOPIC: REGULATION A TYPE: DEFINITIONS 16-1 Chapter 016 Raising Capital A prospectus is a legal document: a issued by the SEC authorizing a new issue of securities b that must be filed with the SEC prior to issuing any new securities c issued by the SEC which outlines the changes required for a registration statement to be approved D which describes the details of a proposed security offering along with relevant information about the issuer e which explains how new securities can be issued without the permission of the SEC SECTION: 16.2 TOPIC: PROSPECTUS TYPE: DEFINITIONS What is a red herring? a newspaper listing of a security offering b negative comments by the SEC on a proposed security offering c a debt issue that matures in less than nine months D a preliminary prospectus e a preliminary assumption that the small-issues exemption applies to an offering SECTION: 16.2 TOPIC: RED HERRING TYPE: DEFINITIONS Advertisements in a financial newspaper announcing a public offering of securities, along with a list of the investment banks handling the offering, are called: a red herrings B tombstones c Green Shoes d registration statements e letters of comment SECTION: 16.2 TOPIC: TOMBSTONE TYPE: DEFINITIONS 16-2 Chapter 016 Raising Capital An issue of securities offered for sale to the general public on a direct cash basis is called a _ offering a best efforts b firm commitment C general cash d rights e red herring SECTION: 16.3 TOPIC: GENERAL CASH OFFER TYPE: DEFINITIONS A public issue of securities where existing shareholders are given the first opportunity to purchase the new securities is called a _ offering a best efforts b firm commitment c general cash D rights e priority SECTION: 16.3 TOPIC: RIGHTS OFFER TYPE: DEFINITIONS A corporation's first sale of equity securities to the public is called a(n): a share repurchase program b shelf registration filing c private placement d seasoned equity offering E initial public offering SECTION: 16.3 TOPIC: INITIAL PUBLIC OFFERING TYPE: DEFINITIONS 16-3 Chapter 016 Raising Capital 10 What is a seasoned equity offering? a shares of stock that have been available for public purchase but remain unsold b shares of stock purchased by an underwriter that can be resold to the general public after six months c equity securities held by a firm's founder that will be offered to the general public once all the IPO shares are sold D sale of newly issued equity shares by a firm that is currently publicly owned e a set number of equity shares that are offered to the public once a year SECTION: 16.3 TOPIC: SEASONED EQUITY OFFERING TYPE: DEFINITIONS 11 The investment banks that act as intermediaries between a securities issuer and the investing public are called: a red herrings b venture capitalists C underwriters d seasoned writers e primary investors SECTION: 16.4 TOPIC: UNDERWRITERS TYPE: DEFINITIONS 12 What is the definition of a syndicate? a a formalized cartel created to control the ownership of a firm b a group of attorneys united for the purpose of taking a private firm public c a group of investors who purchase sufficient equity shares such that they can control the operations of a public corporation d a group of bankers who jointly loan funds to finance the start-up of a new firm E a group of underwriters formed to share the risk of marketing and distributing new securities to the investing public SECTION: 16.4 TOPIC: SYNDICATE TYPE: DEFINITIONS 16-4 Chapter 016 Raising Capital 13 The difference between the underwriters' buying price and the offering price of the securities to the public is called the: A gross spread b underpricing c filing fee d new issue premium e extortion premium SECTION: 16.4 TOPIC: GROSS SPREAD TYPE: DEFINITIONS 14 The type of underwriting in which a syndicate buys the entire issue from the issuing firm and assumes full financial responsibility for any unsold shares, is called a _ offering a best efforts b shelf c direct rights d private placement E firm commitment SECTION: 16.4 TOPIC: FIRM COMMITMENT UNDERWRITING TYPE: DEFINITIONS 15 The type of underwriting where a syndicate sells as much of an issue as possible, but can return any unsold securities to the issuing firm without any further financial responsibility, is called a _ offering A best efforts b shelf c direct rights d private placement e firm commitment SECTION: 16.4 TOPIC: BEST EFFORTS UNDERWRITING TYPE: DEFINITIONS 16-5 Chapter 016 Raising Capital 16 The 40 day period following an IPO during which the SEC places restrictions on the public communications of the issuer is known as the _ period a silent B quiet c lockup d green e red SECTION: 16.4 TOPIC: QUIET PERIOD TYPE: DEFINITIONS 17 A lockup agreement is an agreement included in an underwriting contract which: a guarantees the purchase of the entire issue by the underwriting syndicate b guarantees that additional shares can be purchased by the underwriting syndicate at the offer price during a stated period of time c prohibits the issuer from offering additional securities for sale for an agreed upon period of time d establishes the gross spread to which the underwriters are entitled as a fee for services E prohibits company insiders from selling their securities to the public during the 180 day period following an IPO SECTION: 16.4 TOPIC: LOCKUP AGREEMENT TYPE: DEFINITIONS 18 The first day a stock trades in the market without a recently declared right attached to the stock is called the: a pre-issue date b aftermarket c declaration date d holder-of-record date E ex-rights date SECTION: 16.8 TOPIC: EX-RIGHTS DATE TYPE: DEFINITIONS 16-6 Chapter 016 Raising Capital 19 The date on which existing shareholders are designated as the recipients of stock rights is called the _ date a pre-issue b offering c declaration D holder-of-record e ex-rights SECTION: 16.8 TOPIC: HOLDER-OF-RECORD DATE TYPE: DEFINITIONS 20 A rights offering in which the underwriting syndicate agrees to purchase the unsubscribed portion of the issue is called a _ underwriting A standby b best efforts c firm commitment d direct fee e tombstone SECTION: 16.8 TOPIC: STANDBY UNDERWRITING TYPE: DEFINITIONS 21 The amount paid to an underwriter who participates in a standby underwriting agreement is called a(n): a gross spread b optional spread C standby fee d additional fee e oversubscription fee SECTION: 16.8 TOPIC: STANDBY FEE TYPE: DEFINITIONS 16-7 Chapter 016 Raising Capital 22 The privilege that allows existing shareholders to purchase unsubscribed shares in a rights offering at the subscription price is called the _ privilege a standby B oversubscription c open offer d new issues e overallotment SECTION: 16.8 TOPIC: OVERSUBSCRIPTION PRIVILEGE TYPE: DEFINITIONS 23 A loss in shareholder value as measured in terms of percentage ownership in the firm, market value of the firm, book value of equity, or earnings per share is known as: a oversubscription b underpricing C dilution d rights pricing e downsampling SECTION: 16.9 TOPIC: DILUTION TYPE: DEFINITIONS 24 Direct business loans typically ranging from one to five years are called: a private placements b debt SEOs c notes payable d debt IPOs E term loans SECTION: 16.10 TOPIC: TERM LOANS TYPE: DEFINITIONS 16-8 Chapter 016 Raising Capital 25 Loans provided directly from a limited number of investors to a corporation with maturities typically in excess of five years are called: A private placements b debt SEOs c notes payable d debt IPOs e term loans SECTION: 16.10 TOPIC: PRIVATE PLACEMENTS TYPE: DEFINITIONS 26 Registration permitted under SEC Rule 415 which allows a company to register all issues it expects to sell within the next two years at one time is called: a a standby registration B a shelf registration c Regulation A d Regulation Q e a private registration SECTION: 16.11 TOPIC: SHELF REGISTRATION TYPE: DEFINITIONS 27 The venture capital provided in the very early stages of financing is commonly referred to as: a preliminary money b introduction money c second-state financing d mezzanine-level financing E seed money SECTION: 16.1 TOPIC: VENTURE CAPITAL TYPE: CONCEPTS 16-9 Chapter 016 Raising Capital 28 Venture capital is primarily found through: a internet web sites b a bidding process c newspaper advertisements D personal contacts e letters submitted to venture capital firms SECTION: 16.1 TOPIC: VENTURE CAPITAL TYPE: CONCEPTS 29 Which one of the following statements concerning venture capital financing is correct? a Venture capitalists desire shares of common stock but avoid preferred stock b Venture capital is relatively easy to acquire in today's market c Venture capitalists rarely assume active roles in the management of the financed firm D Venture capitalists often require at least a forty percent equity position as a condition of financing e Venture capital is relatively inexpensive in today's competitive markets SECTION: 16.1 TOPIC: VENTURE CAPITAL TYPE: CONCEPTS 30 Which one of the following statements concerning venture capitalists is correct? a All venture capitalists become actively involved in the day-to-day management of the financed firm B Financial strength is a key consideration when selecting a venture capitalist c Venture capitalists seldom offer any benefit other than the funds they provide d Most venture capitalists are long-term investors in a firm e A venture capitalists exit plan is relatively unimportant SECTION: 16.1 TOPIC: VENTURE CAPITAL TYPE: CONCEPTS 16-10 Chapter 016 Raising Capital 59 Kathleen has an outstanding order with her stock broker to purchase 200 shares of every IPO The next three IPOs are each priced at $18 a share and will all start trading on the same day Kathleen is allocated 100 shares of IPO A, 30 shares of IPO B, and 200 shares of IPO C On the first day of trading IPO A opened at $18.50 a share and ended the day at $19 a share IPO B opened at $22 a share and finished the day at $29 a share IPO C opened at $17 a share and ended the day at $12 a share What is Kathleen's total profit or loss on these three IPOs as of the end of the first day of trading? a $1,200 B $770 c $740 d $30 e $0 Total profit = [100 ($19 $330 $1,200 = $770 $18)] + [30 ($29 $18)] + [200 ($12 $18)] = $100 + AACSB TOPIC: ANALYTIC SECTION: 16.5 TOPIC: IPO ALLOCATIONS TYPE: PROBLEMS 60 Two IPOs will commence trading next week Andrew places an order to buy 500 shares of IPO A Jessica places an order to purchase 300 shares of IPO A and 200 shares of IPO B Both IPOs are priced at $30 a share Andrew is allocated 150 shares of IPO A Jessica is allocated 100 shares of IPO A and 200 shares of IPO B At the end of the first day of trading, IPO A is selling for $32 a share and IPO B is selling for $28 a share What is the difference in the total profits or losses that Andrew and Jessica have as of the end of the first day of trading? a $100 b $200 c $300 d $400 E $500 Andrew's profit = 150 ($32 $30) = $300; Jessica's profit = [100 ($32 $30)] + [200 ($28 $30)] = $200 $400 = $200; Difference = $300 ( $200) = $500 AACSB TOPIC: ANALYTIC SECTION: 16.5 TOPIC: IPO ALLOCATIONS TYPE: PROBLEMS 16-24 Chapter 016 Raising Capital 16-25 Chapter 016 Raising Capital 61 Top Notch, Inc is expanding and needs $5 million to help fund this growth Top Notch estimates they can sell new shares of stock for $25 a share They also estimate that it will cost an additional $200,000 for filing and legal fees related to the stock issue The underwriters have agreed to an percent spread How many shares of stock must Top Notch sell if they are going to have $5 million available for their expansion needs? a 207,360 shares b 208,696 shares c 217,391 shares d 224,640 shares E 226,087 shares Total value of issue = ($5,000,000 + $200,000) / (1 08) = $5,652,173.91; Number of shares needed = $5,652,173.91 / $25 = 226,086.96 = 226,087 shares AACSB TOPIC: ANALYTIC SECTION: 16.4 AND 16.7 TOPIC: FLOTATION COSTS TYPE: PROBLEMS 62 Phillip's Manufacturing wants to raise $15 million to open a new production center The company estimates the issue costs including the legal and accounting fees will be $530,000 The underwriters have set the stock price at $23 a share and the underwriting spread at 8.5 percent How many shares of stock does Phillip's have to sell to meet their cash need? a 707,609 shares b 712,758 shares c 732,611 shares D 737,943 shares e 749,287 shares Total value of issue = ($15,000,000 + $530,000) / (1 085) = $16,972,677.60; Number of shares needed = $16,972,677.60 / $23 = 737,942.50 = 737,943 shares AACSB TOPIC: ANALYTIC SECTION: 16.4 AND 16.7 TOPIC: FLOTATION COSTS TYPE: PROBLEMS 16-26 Chapter 016 Raising Capital 63 Jack's Camping Equipment needs $30 million to finance a new facility to manufacture outdoor grills The management has met with underwriters who feel that the firm could sell additional shares of stock at $19 a share with a percent underwriting spread The estimated issue costs are $315,000 How many shares of stock will Jack's need to sell if they choose firm commitment underwriting for their new facility? a 1,697,793 shares b 1,706,053 shares c 1,707,213 shares D 1,715,620 shares e 1,721,321 shares Total value of issue = ($30,000,000 + $315,000) / (1 07) = $32,596,774.19; Number of shares needed = $32,596,774.19 / $19 = 1,715,619.69 = 1,715,620 shares AACSB TOPIC: ANALYTIC SECTION: 16.4 AND 16.7 TOPIC: FLOTATION COSTS TYPE: PROBLEMS 64 Electrical Services, Inc would like to expand its operations and would require $2 million in additional funding to this After discussing this with shareholders, Electrical Services has decided to raise the necessary funds through a rights offering with a subscription price of $24 a share The current market price of their stock is $30 a share How many shares of stock will Electrical Services need to sell through the rights offering to fund the expansion plans? a 66,667 shares B 83,333 shares c 133,333 shares d 166,667 shares e 333,333 shares $2,000,000 / $24 = 83,333.33 = 83,333 shares AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: SHARES NEEDED IN A RIGHTS OFFERING TYPE: PROBLEMS 16-27 Chapter 016 Raising Capital 65 Wheat Growers, Inc wants to raise $27 million through a rights offering so they can purchase additional acreage to enhance their growing capacity How many shares of stock will the firm need to sell through this offering if the current market price is $43 a share and the subscription price is $35 a share? a 509,434 shares b 627,907 shares C 771,429 shares d 794,118 shares e 800,032 shares $27,000,000 / $35 = 771,428.57 = 771,429 shares AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: SHARES NEEDED IN A RIGHTS OFFERING TYPE: PROBLEMS 66 The Blackberry Co plans on raising $10 million through a rights offering The subscription price is set at $16 Currently, the company has 1.6 million shares outstanding with a current market price of $19.50 a share Each shareholder will receive one right for each share of stock they currently own How many rights will be needed to purchase one new share of stock in this offering? a .56 rights b 1.60 rights C 2.56 rights d 3.12 rights e 4.37 rights Number of rights issued = 1.6m = 1.6m; Number of shares needed = $10m / $16 = 625m; Rights needed for each new share = 1.6m / 625m = 2.56 rights AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: NUMBER OF RIGHTS TYPE: PROBLEMS 16-28 Chapter 016 Raising Capital 67 Winning Sportswear wants to raise $3 million through a rights offering to renovate their current facilities The subscription price for the offering is set at $20 a share Currently, the company has 120,000 shares of stock outstanding at a market price of $25 a share Each shareholder will receive one right for each share of stock they own How many rights will be needed to purchase one new share of stock in this offering? A 0.8 rights b 1.0 rights c 1.2 rights d 1.4 rights e 1.6 rights Number of rights issued = 120,000 = 120,000; Number of shares needed = $3m / $20 = 150,000; Rights needed for each new share = 120,000 / 150,000 = 80 rights AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: NUMBER OF RIGHTS TYPE: PROBLEMS 68 The Miller Brothers Co wants to expand their operations into the blueberry business They need $5 million to buy land and establish a distribution system Currently, the firm has 1,100,000 shares of stock outstanding The market price of the stock is $46.75 a share The Miller Brothers Co decides to raise the needed capital through a rights offering wherein every stockholder will receive one right for every share of stock they own The subscription price will be $40 How many rights will be needed to purchase one new share of stock in this offering? a 1.5 rights b 4.4 rights c 6.0 rights D 8.8 rights e 10.3 rights Number of rights issued = 1.1m = 1.1m; Number of shares needed = $5m / $40 = 125,000; Rights needed for each new share = 1,100,000 / 125,000 = 8.8 rights AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: NUMBER OF RIGHTS TYPE: PROBLEMS 16-29 Chapter 016 Raising Capital 69 Hamilton, Inc is issuing a rights offering wherein every shareholder will receive one right for every share of stock they own The new shares in this offering are priced at $30 plus rights The current market price of Hamilton, Inc stock is $34.50 a share What is the value of one right? a $1.00 B $1.50 c $2.25 d $3.00 e $4.50 Value per share excluding right = [$30 + (2 Value of one right = $34.50 $33 = $1.50 $34.50)] / (1 + 2) = $99 / = $33 AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: VALUE OF A RIGHT TYPE: PROBLEMS 70 The stock of Byron Enterprises is currently selling for $48 a share The company has decided to raise funds through a rights offering wherein every shareholder will receive one right for every share of stock they own The new shares being offered are priced at $42 plus five rights What is the value of one right? a $.20 b $.50 C $1.00 d $5.00 e $6.00 Cost per share = [$42 + (5 $48)] / (1 + 5) = $47; Value of right = $48 AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: VALUE OF A RIGHT TYPE: PROBLEMS 16-30 $47 = $1 Chapter 016 Raising Capital 71 Nester, Inc has decided to raise $3 million in additional funding via a rights offering Every shareholder will receive one right for every share of stock they own The offering consists of a total of 375,000 new shares The current market price of Nester's stock is $20 Currently, there are 1.875 million shares outstanding What is the value of one right? a $1.00 b $1.60 C $2.00 d $3.00 e $3.60 Subscription price = $3m / 375,000 shares = $8 a share; Number of shares issued = 1.875m = 1.875m; Number of rights needed = 1.875m / 375,000 = 5; Cost per share = [$8 + (5 $20)] / (1 + 5) = $18; Value of a right = $20 $18 = $2 AACSB TOPIC: ANALYTIC SECTION: 16.8 TOPIC: VALUE OF A RIGHT TYPE: PROBLEMS 72 You currently own 10 percent of the million outstanding shares of the Perry Co.The company has just announced a rights offering with a subscription price of $30 Every shareholder will receive one right for every share of stock they own This offering will provided $15 million of new financing for the firm, ignoring all issue costs What will be your new ownership position if you opt to sell your rights rather than exercise them? a 2.5 percent b 3.5 percent c 5.0 percent D 8.0 percent e 10.0 percent Number of shares owned = 10 2m = 200,000 shares; Number of shares offered = $15m / $30 = 5m shares; New ownership position = 200,000 / (2m + 5m) = percent AACSB TOPIC: ANALYTIC SECTION: 16.9 TOPIC: OWNERSHIP DILUTION TYPE: PROBLEMS 16-31 Chapter 016 Raising Capital 73 Eileen owns 27,000 shares of stock in the Film Production Company Currently, there are 800,000 shares of stock outstanding The company has just announced a rights offering whereby 100,000 shares are being offered for sale at a subscription price of $20 a share The current stock price is $28 a share Assume that Eileen sells her rights and that all rights are exercised What will Eileen's ownership percentage in the Film Production Company be after the rights are exercised? a 1.5 percent b 2.0 percent C 3.0 percent d 3.5 percent e 4.0 percent New ownership percentage = 27,000 / (800,000 + 100,000) = 03 = percent AACSB TOPIC: ANALYTIC SECTION: 16.9 TOPIC: OWNERSHIP DILUTION TYPE: PROBLEMS 16-32 Chapter 016 Raising Capital 74 The Jenkins Co is considering a project which requires the purchase of $315,000 of fixed assets The net present value of the project is $20,000 Equity shares will be issued as the sole means of financing the project What will the new book value per share be after the project is implemented given the following current information on the firm? a $9.97 b $10.88 C $11.34 d $13.15 e $15.70 Current market value per share = $720,000 / 50,000 = $14.40; Number of new shares needed = $315,000 / $14.40 = 21,875 shares; New book value per share = ($500,000 + $315,000) / (50,000 + 21,875) = $11.34 AACSB TOPIC: ANALYTIC SECTION: 16.9 TOPIC: DILUTION [IMAGE] ACCOUNTING AND FINANCIAL TYPE: PROBLEMS 16-33 Chapter 016 Raising Capital 75 The Jenkins Co is considering a project which requires the purchase of $315,000 of fixed assets The net present value of the project is $20,000 Equity shares will be issued as the sole means of financing the project The price-earnings ratio of the project equals that of the existing firm What will the new market value per share be after the project is implemented given the following current information on the firm? a $10.00 b $10.37 c $12.07 D $14.68 e $15.04 Current market value per share = $720,000 / 50,000 = $14.40; Number of new shares needed = $315,000 / $14.40 = 21,875 shares; New market value per share = ($720,000 + $315,000 + $20,000) / (50,000 + 21,875) = $14.68 AACSB TOPIC: ANALYTIC SECTION: 16.9 TOPIC: DILUTION [IMAGE] ACCOUNTING AND FINANCIAL TYPE: PROBLEMS 16-34 Chapter 016 Raising Capital 76 Wagner Trucking is considering investing in a new project that will cost $6 million and increase net income by percent This project will be completely funded by issuing new equity shares Currently, the firm has million shares of stock outstanding with a market price of $30 per share The current earnings per share are $1.60 What will the earnings per share be if the project is implemented? a $1.39 b $1.45 C $1.53 d $1.60 e $1.68 New earnings per share = ($1.60 2m 1.05) / [2m + ($6m / $30)] = $1.527 = $1.53 AACSB TOPIC: ANALYTIC SECTION: 16.9 TOPIC: DILUTION [IMAGE] EARNINGS PER SHARE TYPE: PROBLEMS 77 You own 10 percent or 5,000 shares of Microprocessors, Inc These shares have a total market value of $115,000 By what percentage will the total value of your investment in Microprocessors change if the company sells an additional 20,000 shares of stock at $18 a share and you not buy any? a 6.63 percent B 6.21 percent c 00 percent d 9.57 percent e 9.82 percent Current number of shares outstanding = 5,000 / 10 = 50,000; Price per share = $115,000 / 5,000 = $23; New market value per share = [(50,000 $23) + (20,000 $18)] / (50,000 + 20,000) = $1,510,000 / 70,000 = $21.57; Percentage change in value = ($21.57 $23) / $23 = 0621 = 6.21 percent AACSB TOPIC: ANALYTIC SECTION: 16.9 TOPIC: DILUTION [IMAGE] PORTFOLIO VALUE TYPE: PROBLEMS 16-35 Chapter 016 Raising Capital 78 Kelly currently owns 20 percent of Peters, Inc The company has a total of 175,000 shares outstanding with a current market price of $25 a share At present, the firm is offering an additional 15,000 shares at a price of $22.50 a share Kelly decides not to participate in this offering What will Kelly's ownership position be after the offering is completed? a 10.00 percent b 11.11 percent c 15.58 percent D 18.42 percent e 20.91 percent Number of shares Kelly owns = 20 175,000 = 35,000; New ownership position = 35,000 / (175,000 + 15,000) = 35,000 / 190,000 = 1842 = 18.42 percent AACSB TOPIC: ANALYTIC SECTION: 16.9 TOPIC: DILUTION [IMAGE] OWNERSHIP POSITION TYPE: PROBLEMS Essay Questions 79 Why should a firm consider utilizing a venture capitalist? What types of characteristics should the firm consider if they decide to pursue this means of financing? The primary advantage of using a venture capitalist is to gain access to capital when funds are unable from other sources In addition, a venture capitalist provides industry experience, expertise, and valuable business contacts A major drawback of using a venture capitalist is the substantial fraction of firm ownership which they demand The five key considerations in choosing a venture capitalist are: AACSB TOPIC: REFLECTIVE THINKING SECTION: 16.1 TOPIC: VENTURE CAPITAL 16-36 Chapter 016 Raising Capital 80 Explain a rights offering and the basic characteristics of a right A rights offering is an issue of common stock that is initially offered for sale to a firm's current shareholders Shareholders generally receive one right for each share of stock owned Each right grants its holder the ability to purchase a stated amount of new shares at a stated price during a stated period of time In other words, each new share of stock can be purchased by paying the offer price and submitting the required number of rights If the recipient of a right decides not to participate in the rights offering, then he or she can sell the right to an investor who does want to participate Selling stock via a rights offering is generally a cheaper method of issuing securities than a general cash offer AACSB TOPIC: REFLECTIVE THINKING SECTION: 16.8 TOPIC: RIGHTS OFFERING 81 Explain why there is a tendency for IPOs to be underpriced Several reasons have been given for underpricing an IPO These include: determining the correct offering price is extremely difficult, underpricing helps ensure the success of the security offering, underpricing is just an indirect cost of a securities issue, underpricing rewards IPO investors for purchasing risky securities, underpricing addresses the issue of the "winner's curse", and underpricing rewards institutional investors for the information they provide to underwriters regarding the potential interest in and value of a security issue AACSB TOPIC: REFLECTIVE THINKING SECTION: 16.5 TOPIC: IPO UNDERPRICING 16-37 Chapter 016 Raising Capital 82 Firms encounter several costs when they decide to issue new securities Identify and describe at least four of these costs Students should provide a partial discussion of the information found at the beginning of section 16.7 where different types of costs are identified and defined These are: AACSB TOPIC: REFLECTIVE THINKING SECTION: 16.7 TOPIC: IPO UNDERPRICING 83 Many underwriting contracts contain both a Green Shoe provision and a lockup agreement Explain the basic characteristics and purpose of each of these A Green Shoe provision grants the underwriters the option of acquiring additional shares of stock from the issuer at the offer price This provision is needed to cover oversubscriptions The provision generally limits the additional number of shares to 15 percent of the original issue and restricts the offer to a period of 30 days.A lockup arrangement prevents company insiders from selling their shares in the firm for 180 days following an IPO This helps maintain both the market price of the stock and also retains the insiders continued interest in the firm In other words, the insiders cannot immediately profit from an IPO, take their profits, and run AACSB TOPIC: REFLECTIVE THINKING SECTION: 16.4 TOPIC: GREEN SHOE PROVISION AND THE LOCKUP ARRANGEMENT 16-38 ... such that they can control the operations of a public corporation d a group of bankers who jointly loan funds to finance the start-up of a new firm E a group of underwriters formed to share the... the securities to the public is called the: A gross spread b underpricing c filing fee d new issue premium e extortion premium SECTION: 16.4 TOPIC: GROSS SPREAD TYPE: DEFINITIONS 14 The type of... proposed security offering c a debt issue that matures in less than nine months D a preliminary prospectus e a preliminary assumption that the small-issues exemption applies to an offering SECTION: