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You have started a company and are in luck—a venture capitalist has offered to invest. You own 100% of the compan illion shares. The VC offers $1.22 million for 855,000 new shares. ? this fee? c. Whaiaetion of the firm willjSUiGHERgRihe inyestaTEHt? a. What is the implied price per share? To determine th&liipliggipsiceipenshare. use the following formula: Smith Brothers, Inc., sold 7 million shares in negotiated a fee (the urrdarwriting spread) dff 10.2% To calculate the total dollar value of the IPO, use the following formula IPO Value = Price per Share x Number of Shares Your investment bankers price your IPO at $16 50 per share for 12.0 million shares. If the price at the end of the first day of trading 1s $18 30 per share, a. what was the percentage underpricing? b. how much money did the firm miss out on due to underpncing? . at a price of $19.15 per share. Management this transaction. What was the dollar cost of A (% D) The underpricing is the difference between the price at the end of the first d: Underpricing = $18.30 - $16.50 = $1 80 As a percent of the offering price, the underpricing is Und - VC Offer Therefore, Percentage of Underpricing = % Number of shares IPO Value = $19.15 per share x 7 million shares = $134.1 million — Therefore, - The total dollar value of the IPO was $134.1 milllion 180 Percentage of Underpricing = w—=—= = 109% 1650 Price = g =$1.43 per share To determine the cost of the underwriter fees, use the following formula s 855,000 shares . . Underwriting Fees = b. What is the post-money valuation? Therefore, To determine the post-money valuation, use the following formula: ' Underwriting Fees = Post-money Valuation = Implied Price per Share X New Total Number of Shares Therefore, The cost of the underwriter fees was $13.68 million b. how much money did the firm miss out on due to underprcing? IPO Value x Underwriter Spread To determine the amount of the forgone money, use the following formula Forgone Money = Underpricing x Number of Shares $134.1 million x 0.102 = $13.68 million Therefore Forgone Money = $1.80 per share x 12.0 million shares =$21.6 million av of tradina and the IPO orice Feton Publishing recently completad its IPO. The stock was offered at $12 13 par share On the first day of trading, the stock closed at $18 61 per share . 'What was the intial return on Felton? b. Who benefited from this underpicing? Who iost, and why? 4. 'What was the intial return on Felton? The ntial return was 417 % (Round 1o one decmal place ) b. Who banefited from this underpacng? (Select the best choice below ) ¥ A Investors who bought shares at the IPO price of $13 13/share and investmant banks (indrectly from future business) Owners of other shares outstandng (not part of the IPO) and underwriers. The company and cwners of other shares outstanding (nol part of the 1PO) The company and underwriers Who lost? (Seiect the best choe below ) ¥ . Owners of other shares outstanding (par of the IPO) Owners of other shares outstanding (not part of the IPO) Both of the above Investors who bought shares at the IPO price of $13 13/share and investment banks (indrectly from future business) RostsmoneyaMaluationi= $1.43 per share x 6,555,000 shares = $9,373,650 c. What fraction of the firm will you own after the investment? To determine your fractional hip, uuse the following formula: Original Number of Shares New Total Number of Shares Fractional Oy hip = Starware Software was founded last year to develop software for gaming applications. The founder initially invested $850.000 and received 7 million shares of stock. Starware now needs to raise a second round of capital, and it has identified a venture capitalist who is interested in investing. This venture capitalist will invest $1.50 million and wants to own 33% of the company after the investment is completed a. How many shares must the venture capitalist receive to end up with 33% of the company? What is the implied price per share of this funding round? b. What will the value of the whole firm be after this investment (the post-money valuation)? To determine the number of shares the venture capitalist must receive, use the following formula None of the above (Select the best choice below The ongnal shareholders who particpated in the IPO soid shares below what the market was wiling to pay The onginal shareholders who partiopated in the IPO s0id shares at what the market was willing 10 pay The onginal shareholders who pariopated n the IPO soid shares above what the market was wiling to pay Assume that Microsoft has a total market value of $310 billion and a marginal tax rate of 35%. If it 5 & D = £ o > 3 o g 2 22s G o = 0Q 5= € 350 3% 8 ‘® O 3 22 0 c >0 =2 Q=0 O = o= =08 0 >9 ac s s5S 833 o - B i 5 2 : = 9% - VO - o - inently changes its leverage from no debt by taking on new debt in the amount of 13.7% of its. a = -7 Therefore. Number of Your Shares = Total Number of Shares x(100% - VC's Percentage) >° L » 2 -E 3 current market value, what I the present vakue of the tax shield it wll rgate? §| g % % gw ? g § 5 2 After the funding round, the founder's 7 million shares will represent 67% ownership of the firm. To solve fol : § E o “;’ 8 3 f § % ® E a & 9 g— w E 5.700.000 shares the new total number of shares (Total): 7,000,000 shares = 67% x Total § © T C=90 i § 8 8= ? 8 E3 g g 3 ; @ o , ) ° 2 S d g g . & W 555000 shares ~ 0.8696 = 86.96% Therefore, Total = 10.448 million shares. If the new total is 10.448 million shares, and the venture capitalist b 5S S 8 g Plan: @ % % E3 % 8 g ‘?<' 2a { . e b Py 8 T b y will end up with 33%, then the venture capitalist must buy 3.448 million shares % =< 5 g 3 To compute the present value of the tax shisld we can use the folowing equation ‘,_,, g g g g € g 2 Z_ To determine the implied price per share, use the following formula: ‘5 -8 §, g * g PV (Interest Tax Shield)= T, xD 30 30 g so ::: g g 5 § . 2 - . 08 o g 2 95 = The firm you founded currently has 18 million shares, of which you own 9 million. You are considering an Pricg = [Miestment Amount 8 g s > D G where T s the marginal corporae tax ate and Ds the amountof debt 'g § & ] gz % § ] million shares for $24.50 each. If all of the shares sold are prim ares, 1% Number of Shares %‘ 3L 5a 2 Exune: 2 4 & & o 2 2 ¥|a =3 ? Wh = 8 5¢ R B ; g & ale ®a faisg+ Therefore, g ® g ‘ ,;_f é @ Use the formula given above to compute the present value of the tax shield | 32 2 oo o g 2 & B3 7 x pod bd prce< S0 milion _ S 2E | 2GR T, 2 T S5 B & ] fice = T———= 7 ] (e 2 ® P 3 3.448 million 2 QLT 3 I 3 s 2 = o £ SE S 35% x ($310 x 13.7%) = $14.86 billion x x Z g e R 3 © o e b 2 Given the investment of $1.50 million for 3.448 million shares, the implied price per share is $0.44 © 5 S* B ;C: k] z The present value of the tax shield is $14.86 billion g g ; % § 0 = c . N = b. What will the value of the whole firm be after this investment (the post-money valuation)? g Q'S : g - é Evaluate: 3 g g 5 TO caICUIate me amount the firm Mn raise, mumP'y ‘he number Of shares SOId by 'he selling pnCe. . g " ko) 8 g 3 § g We know that in perfect capital mflrkols financing transactions have an NPV of zero. However, the ‘§ @ g '8 To determine the post-money valuation, use the following formula. % s 5 3 .- interest tax deductibility makes e-NPV transaction for the firm. The total value of the leverec Z § =4 5 O O f he f verage due to the present value of the tay savinas from deht 2l g Therefore, Post-money Valuation = Price per Share x Number of Shares 2 4 % > S T There is an important tax advantage to the use of debt financing = o g ;% S o Q9 '8 = I 3 aac 7o Therefore, o 9O c 2 . s ATGIRPREIEET 24 million x$24.50 = $98.0 million 852 2o 8 % 5 £ g 2 it Post-money Valuation = $0.44 x 10.448 million = $4.597 million = .5 2 g 3 2 al+ - S 8 5 § s P g s o B k3 o ) If the firm sells 4 million primary shares at $24.50 each, the firm will raise $98.0 million. After this investment, there will be 10.448 million shares outstanding, with a price of $0.44 per share, so H o5 7] p 2 E v w = g § g F the post-money valuation is $4 597 million § 329 %‘ 222 Q 8 ¢« 9 2 < ® The total number of shares outstanding after the IPO will be 22 million. To determine the percentage that Stopose b copore ks 3T Cooie 3 Bt e $5500 i aaminge btrs bt o sty v ol S 3 g 2 TR =3 + o ~ 3 g > g S Capraciation 563 8ach year. and it wil have 1o changes 1o its net working capital 9% - = oS 8’ S © > X [} - £ you own, use the followng formula: o. Suppose the {im has no debd and pays out ts net income s & umam each year Mal is the value a!mrmnq‘y’ S = 2 a g, Q + = 3 3 o g ® ’ b. Suppor of $1,500 per year What is the value of equily? What is the value of debt? .8 £3 > R 8 c's w |+ — ~ @ P o c \-nm i the dfference betwaen m total value of the firm with loverage and without laverage? g S e 8 © 7 w 8 " 8’ » g g 2 d. Towhat of the valus of the debt is the dfferance in » ® 8 F 3 m Number of Shares You Own _ / 0 Oq o s e Misrsnce b par () $qual 558 = w5 % u g § bt H s : = = 3 Qo > [S) - < P = ~Total Number of Shares Y} < 2 >3 SREEZ I L g % 2 g 5 Net Income = $5 500 x(1 - 37 %) = $3465 é - §.§ g(n T < Q L ":) = ; : Z 8 Therafara The value of the netIncome of the no-deb frmis $3,465 & @ vy =0 s g ‘;‘ £ e i g 3 & 5 . - C < 3 g e rdmon Enterprises is currently an all-equity firm with an expected return of 17.25%. Itis considering a leveraged recapitalization in which it would borrow and repurchase existing shares Assunp pei™en. 1o find the vaue of the equily, use the following formuda g 298 g 2 § > EJ o o g 8 pital markets. sty Vaige = SXPECid Cash Flow >EDVO n=< 8 - (= & ‘ S Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is 7%. What will be the expected return of equity after this transaction? N Costof Caplal P Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be 9%. What wi yest sbove and pital |8 the risk-free rute - S I S _ 4 C————— - pected retum of equity in this case? o B Pelamed Pharmaceuticals had EBITo[) 5525 mnlxon in 2010 In ada"uon Pelamed had interest expenses oi $236 mclllon and a cofporale tax rate of 37%. Asenior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected retun for the stock. How would you respond to this arlume s & m: b4 ;fiifi‘:fi;éflggj}?%’:‘: bt incote i Kitarwst paymonts? Milton Industries expects freaicash flows of $22 million each year. Milton's corporate tax rate is 37%, Equity Value = == =338,500 and its unlevered cost of capital is 17%. Milton also has outstanding debt of $63.41 million, and it c. If Pelamed had no interest expenses, what would have been its 2010 net income? How does it compare to your ansm Suppose Haramon bofrows 1o the point that its debt-equity ratio IS U.5U. With this amount of debt, the debt cost of capital 5 /%. WNat will De the expected return of equity after this transaction’ compute the expected retum of equity, use the following formula: D IE=IU+Ex ((U—ID) e = Expected return (cost of capital) of levered equity fy = Expected retumn (cost of capital) of unlevered equity i = Expected retum on debt D = Market value of debt E = Market value of levered equity ing the formula above, the equation is: rg=17.25%+0.50%(17.25% - 7%) = 22.38% e expected retum is 22.38%. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be 9%. Wh pected retum of equity in this case? ing the formula above, the equation is: rg=17.25% +1.50(17.25% - 9%) = 29.63% e expected retum is 29.63%. A senior manager argues that itis in the best interest of the shareholders to choose the capital structure that leads to the highest expected retum for the stock. How would you respond to this ar] se, because retums are higher because risk is higher and the retum fairly compensates for the risk M the fem has no dabt and pays out its net income a5 3 dividend each year, tha value of the frmi's equity is $38.500 d. What is the amount of Pelamed's interest tax shield in 2010? xpects to maintain this level of debt permanently. a. What is the value of! b. What is the value o W i totsl ge and without leverage? R — — S of 1 Whatis th aquity? What i of dabt? 500 poc yoer. Whatls the valoe o s thaalie Net Income = ($525 million - $236 million) x (1 - 0.37) = $182 million To fnd the g the Net - ST otarast B e The 2010 net income is $182 million Thersfore. b. What is the total of Pelamed's 2010 net income plus interest payments? WOk couss < URINY = VARG CE = TN S SR To find the total net income plus interest expense, use the following formula i of income i the frm mak f$1,500 Is $2.520. Total Net Income and Interest Expense = Net Income + Interest Then, 1o find tha value of the aquity, use the folowing formuta Therefore, Interest Payment = Debt x Interest rate Total Net Income and Interest Expense = $182 million + $236 million = $418 million To determine the value of debt, D, use the following formula The total of Pelamed's 2010 net income plus interest payments is $418 million. _ Interest Payment Risk-free Rate % c. If Pelamed had no interest expenses, what would have been its 2010 net income? How does it compare to your answi Therefore, To find the net income if there were no interest, use the following formula: $1,500 Net Income = EBIT - Taxes T T Tadel Therefore, If the firm makes interest payments of $1,500 per year, the value of debt is $16,667 Net Income = $525 million X (1 - 0.37) = $331 million d. To what percentage of the value of the debt is the difference in part (c) equal? t will be To find the value of the firm with leverage, use the following formula: Therefore, d \W " lvapw 3 V=528,000+516667=544667 \, \ 0 W®Jf C) The value of the firm with leverage is $44,667. . Jument’ To find the value of the firm without leverage, in the value of The 2010 net income would be $331 million The 2010 net income with no interest expense is $149 million higher than the 2010 net income with interest expense, V=E+D Difference = Net Income without Interest Expense - Net Income with Interest Expense Difference = $331 million - $182 million = $149 million d. What is the amount of Pelamed'’s interest tax shield in 20107 To find the interest tax shield, use the following formula: unlevered equity found in part (a), therefore the value of the firm without leverage is $38,500. — ey a. What is the value of Milton Industries without leverage? To find the value of Milton Industries without leverage, use the following formula U_ Free Cash Flow ~ Unlevered Cost of Capital where: vV =value of firm without leverage Therefore, $22 million W= ~oq7 =$129.41 milion The value of Milton Industries without leverage is $129.41 million b. What is the value of Milton Industries with leverage? To find the value of Milton Industries with leverage, use the following formula: =Ws PV(Interest Tax Shield) where: vt =value of firm with leverage and PV(Interest Tax Shield) = T xD Therefore, V= $129.41 million +£0.37 x$63.41 mil% $152.87 million The value of Milton Industries with leverage is $152.87 million.