3 Spartans Investment House is an underwriting firm speciali

3. Spartans Investment House is an underwriting firm specializing in iial public offerings (IPOs). Spartans is hired to underwrite an issue of 7.5 million shares of stock for MyFace, a private social media firm looking to go public. a. Spartans agrees to underwrite the stock on a firm commitment bas shares. is, paying $8.75 per share for 7.5 million i. If the IPO price is S9.50, how much capital does MyFace raise? How much profit (or loss) does Spartans earn? (2 points) ii. If the IPO price is S7.95, how much capital does MyFace raise? How much profit (or loss) does Spartans earn? (2 points) b. Spartans agrees to underwrite the stock on a best efforts basis. The underwriter is able to sell 6.8 million shares charges a commission of S0.257 per share. i. If the underwriter is able to sell the stock at $9.50 per share, how much capital does MyFace raise? How much profit (or loss) does Spartans earn? (2 points) ii. If the underwriter is able to sell the stock at $7.95 per share, how much capital does MyFace raise? How much profit (or loss) does Spartans earn? (2 points) c. Which party (Firm or Underwriter) bears the price risk in a Firm Commitment? Which party bears the price risk in a Best Efforts? Explain. (2 points)

Solution

3 a ) i) In firm Commitment basis, underwriter agrees to purchase all securirites being offered for sale by issuer regardless of whether they are able to sell or not

Issuer is issuing 7.5 million shares. Underwriter agrees to pay $8.75 per share.

Capital raised by MyFace = Number of shares offered x Per share price agreed

Capital raised by MyFace = 7.5 million X 8.75 = $65.625 million

Profit/Loss of Spartans = (IPO price - committed price )x Shares sold = (9.5-8.75)X7.5 million = $5.625 Million (Profit)

3 a) ii)

Capital raised by MyFace = Number of shares offered x Per share price agreed

Capital raised by MyFace = 7.5 million X 7.95 = $59.625 million

Profit/Loss of Spartans = (IPO price - committed price )x Shares sold = (7.95-8.75)X7.5 million = -$6 Million (Loss)

3 b i)

Capital raised by MyFace = Number of shares sold x (Per share price - commision per share)

Capital raised by MyFace = 6.8 million X (9.5 - 0.257) = $62.8524 million

Profit / Loss of Spartans = Number of shares sold x commision per share

Profit / Loss of Spartans = 6.8 million x 0.257 =$ 1.7476 million (Profit)

b ) ii)

Capital raised by MyFace = Number of shares sold x (Per share price - commision per share)

Capital raised by MyFace = 6.8 million X (7.95 - 0.257) = $52.3124 million

Profit / Loss of Spartans = Number of shares sold x commision per share

Profit / Loss of Spartans = 6.8 million x 0.257 =$ 1.7476 million (Profit)

c)

In firm Commitment basis, underwriter agrees to purchase all securirites being offered for sale by issuer regardless of whether they are able to sell or not

In best effort basis, Underwirter agrees to make best effort to sell the securities but does not guarantee the sale

As evident from above example, in firm commitment basis, risk lies with underwriter while that in best effort, risk lies with issuer