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

Question 1

Since providing updated information about company activities and status is costly, it has absolutely no advantage for firms.

Answer 1

False

Question 2

Going public establishes a market value for the firm's shares, 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.

Answer 2

False

Question 3

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.

Answer 3

True

Question 4

Best efforts deals are commonly used by well-known, established issuers.

Question 5

The term "leaving money on the table" refers to the situation where an investment bank makes a very low bid for the right to underwrite a firm's new stock offering. The banker is, in effect, "buying the job" with the low bid and thus not getting all the money his firm would normally earn on the job.

Question 6

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

Question 7

The secondary market is a second-hand market in which securities are sold by the first and subsequent buyers.

Question 8

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

Question 9

The ICE Futures Canada, originated from the Winnipeg Stock Exchange, is Canada's exchange trading derivatives products.

Question 10

Securities traded in the stock exchanges are primary market transactions as the sales proceeds go to the issuing companies.

Question 11

The trading of existing equity issues among investors occurs in the capital market.

Question 12

Personal assets and "love money" are the two major sources of equity capital for a start-up company.

Question 13

Syndicated offerings gain publicity because institutional investors are involved with marketing functions.

Question 14

Alpha and Pure Trading System are the two electronic communications networks used by dealers in the trading floor of the TSX exchange.

Question 15

A bought deal occurs when underwriter buys an issue from a firm and sells the securities to investors without preparing a prospectus.

Question 16

For providing funds to start-up firms, venture capital investors would like to be equity holders getting stocks rather than just being lenders.

Question 17

Exchange traded funds (ETFs) can be bought and sold in dealer markets anytime during the day.

Question 18

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

Question 19

Going public means a company is required to disclose information to the public for investigation.

Question 20

The big payoff for the entrepreneur and venture capitalist is when the firm is closely held by its founders.

Question 21

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

A) undertake the issue on a best efforts basis
B) reduce the spread
C) cut short the roadshows
D) apply a shelf prospectus for the issue

Question 22

Once approved with a shelf prospectus, firms have the right to sell new stocks anytime up to a 25- month period by extending investors with a prospectus supplement.

Question 23

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.

Question 24

Investment banks sometimes act as an agent for the issuer on a best efforts basis, whereby they are paid with a fixed commission.

Question 25

The Investment Industry Regulatory Organization of Canada, combining Investment Dealers Association and Market Regulation Services Inc., is a federal government supervisory agency for the securities industry.

Question 26

In order to secure investor interests, underwriters would like to provide more information during the roadshow presentations than what has been given in the prospectus.

Question 27

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Question 28

One big advantage of going private through a leverage buyout is the tax shields from the borrowing.

Question 29

With no recourse, firms prefer to use project financing for risky but small capital investments.

Question 30

Which of the following entities does NOT belong to the TMX Group?

A) Toronto Stock Exchange
B) ICE Futures Canada
C) Montreal Exchange
D) TSX Venture Exchange

Question 31

The term "equity carve-out" refers to the situation where a firm's managers give themselves the right to purchase new stock at a price far below the going market price. Since this dilutes the value of the public stockholders, it "carves out" some of their value.

Question 32

Which of the following is generally NOT true and an advantage of going public?

A) facilitates stockholder diversification
B) increases the liquidity of the firm's stock
C) establishes a market value for the firm
D) makes it easier for owner-managers to engage in profitable self-dealings

Question 33

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.

Question 34

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.

Question 35

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

A) Listing is a decision of more significance to a firm than going public.
B) Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.
C) Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the security commission.
D) The OTC is the second largest market for listed stock, and it is exceeded only by the TSX.

Question 36

What is the money offered to fund a start-up company?

A) a private placement
B) a bought deal
C) project financing
D) venture capital fund

Question 37

Which of the following stock index is NOT value weighted?

A) Dow Jones industrial Average (DJIA).
B) S&P 500 Index.
C) S&P/TSX 60 Index.
D) NYSE Composite Index.

Question 38

The principal activities of investment banks are (1) to help firms issue new stock and bonds and (2) to give firms advice with regard to mergers and other financial matters. However, financial corporations often own and operate subsidiaries that operate as commercial banks and others that are investment banks. This was not true some years ago, when the two types of banks were required by law to be completely independent of one another.

Question 39

What is the average spread of new security issues in Canada?

A) 5.0%
B) 5.5%
C) 6.0%
D) 7.0%

Question 40

What is a seasoned equity offering?

A) Shares are sold by founding members from their holdings in the primary market.
B) The unsubscribed new shares from the previous IPO are sold in the secondary market.
C) New shares are sold to the general public by companies in the primary market.
D) Used shares are sold to existing shareholders in the secondary market.

Question 41

Which of the following is true about equity carve-outs?

A) They are overpriced issues.
B) They are sold by private placements.
C) No prospectus is required.
D) They are a special type of IPO.

Question 42

Which of the following is an advantage of going private?

A) reduced managerial flexibility
B) lower shareholder participation
C) higher cost in security registration
D) increased managerial efficiency

Question 43

Which of the following statements best describes debt?

A) If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.
B) The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.
C) The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
D) If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.

Question 44

Which of the following is true concerning bought deals?

A) They reduce risk to underwriters.
B) They are also known as follow-on offerings.
C) They involve large orders (with 10,000 shares or more).

Question 45

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?

A) $20.0 million
B) $18.0 million
C) $15.0 million
D) $13.5 million

Question 46

Which of the following firms is qualified to issue new stock under the short-form prospectus distribution?

A) well-established large corporations
B) new start-up small companies
C) government subsidiaries

Question 47

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

A) underwriting fees paid to underwriters
B) direct issuing costs
C) oversubscription option
D) overpricing

Question 48

Which of the following statements concerning common stock and the investment banking process is INCORRECT?

A) The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.
B) If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.
C) Listing a large firm's stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.
D) Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management's performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.

Question 49

Who can benefit from a syndicated offering?

A) issuers
B) underwriters
C) both (a) and (b)
D) neither (a) nor (b)

Question 50

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

A) The yield to maturity on the company's outstanding bonds increases due to a weakening of the firm's financial situation.
B) A provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates.
C) The flotation costs associated with issuing new bonds rise.
D) The firm's CFO believes that interest rates are likely to decline in the future.

Question 51

An entrepreneur first started his business with $100,000. Later, a venture capitalist 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

Question 52

Consider the following information about an IPO. The net proceeds to the issuing firm are $141.75 million. The public offering price is $50 per share. The spread is $2.75 per share. Two million shares are sold. How many shares are issued in this IPO?

A) 3,500,000
B) 3,000,000
C) 2,500,000
D) 2,000,000

Question 53

Which of the following is true about leveraged buyouts?

A) LBOs will not benefit public shareholders.
B) Incumbent management may be penalized by LBOs.
C) LBOs do not affect the asset values of the company.

Question 54

An underwriter follows a best efforts basis to sell 2 million shares at $10 a piece. Such a public offering price has included a $1 spread. How much will the issuer receive if only 1.5 million shares are sold in this issue?

A) $20.0 million
B) $18.0 million
C) $15.0 million
D) $13.5 million

Question 55

Why does underpricing always occur for an IPO?

A) to guarantee sales by underwriters
B) to discourage oversubscription from investors
C) to reward customers by issuers
D) to protect investors from deceptive firms

Question 56

Which of the following is true regarding the Canadian securities industry?

A) The industry is very concentrated.
B) The industry is unregulated.
C) The industry is not governed nationally.
D) The industry is supervised by the Canadian Security Association.

Question 57

Which of the following statements best describes private placements?

A) In a private placement, securities are sold to private (individual) investors rather than to institutions.
B) Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
C) Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
D) Private placements can generally bring in funds faster than is the case with public offerings.

Question 58

Which of the following statements is INCORRECT?

A) When a corporation's shares are owned by a few individuals who own most of the stock or are part of the firm's management, we say that the firm is "closely, or privately, held."
B) "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.
C) When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.
D) It is possible for a firm to go public and yet not raise any additional new capital.

Question 59

What is likely to happen when a shelf prospectus system is adopted for corporations issuing securities?

A) The time for raising capital will increase.
B) The competition among underwriters will increase.
C) The profit of the issuers will decrease.
D) The underwriting expenses will increase.

Question 60

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

A) smaller-scale but complex projects
B) large-scale and stable projects
C) smaller-scale and independent projects
D) large-scale and risky projects

Question 61

The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?

A) $6,480
B) $7,200
C) $8,000
D) $8,800

Question 62

What is the NPV if ABCW refunds its bonds today?

A) $1,746,987
B) $1,838,933
C) $1,935,719
D) $2,037,599

Question 63

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.

A) $1,300,973
B) $1,369,446
C) $1,441,522
D) $1,517,391

Question 64

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 issuing 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 three 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 three separate issues?

A) $79,425
B) $83,606
C) $88,006
D) $92,406

Question 65

Thompson Enterprises has $5,000,000 of bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%, and 15 years left to maturity. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations-assume that the firm's tax rate is zero.
The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

A) 9.57%
B) 10.07%
C) 10.60%
D) 11.16%

Question 66

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"?

A) 9.29%
B) 9.78%
C) 10.29%
D) 10.81%

Question 67

What will the after-tax annual interest savings for ABCW be if the refunding takes place?

A) $664,050
B) $699,000
C) $768,900
D) $845,790

Question 68

What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

A) $5,315,725
B) $5,595,500
C) $5,890,000
D) $6,200,000

Question 69

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?

A) 11.50%
B) 10.00%
C) 9.10%
D) 8.40%