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Finance Problem Set: IPO in current economy, Determine Discount Rates, and CAPM for Personal Decisions

1. Given the current state of the economy, do you think right now would be a good time to take a company public? What would be the advantages and disadvantages of going through the IPO process at this time as opposed to waiting a year or two?

2. Discount rates will vary based upon your own personal level of risk tolerance. For example, I might be willing to buy a risky stock if I think I'll earn 10% while my wife would need at least 20% before she'd consider it. What's your discount rate for the following types of equities? How did you determine that rate?

a) A risk free equity (a US Treasury Note - called risk free because if they can't pay, your money is worthless!)
b) A CD at a South American bank paying in their local currency.
c) A stock in a company that has a secure stream of income from a long term contract customer.
d) A stock in a company that has an interesting business plan but no real operations as of yet (as NY Lotto says "A Dollar and A Dream")

And in addition, how would the recent huge fluctuations in the stock market affect your original response to the initial part of this question .

3. Would you ever use Capital Asset Pricing Model (CAPM) to make personal investment decisions? Why or why not?

Note: the main message of the CAPM is the notion of diversification of investments. At least theoretically investors should only invest in two portfolios: one is the Market Portfolio (such as the S&P500 Index) and the other is a portfolio of short term or money market default-free securities.

Solution Preview

1. Given the current state of the economy, do you think right now would be a good time to take a company public? What would be the advantages and disadvantages of going through the IPO process at this time as opposed to waiting a year or two?

Anytime is a good time to take company public. The requirement depends on the capital needs and should not be based on timing the market. Even though the market is down, this would also the right time to take company public.
The advantage of going public now would be that the company would get access to cash which is difficult since the credit markets are not functioning normally and getting debt is becoming difficult. Thus the cash can be used for the activities of then firm. If we wait for some time, and we are not able to meet our credit needs through the banks, then the future of the company would be in jeopardy.

The disadvantage would be that the shares would have to be issued at a lower price as compared to when the equity markets were doing well and to that extent, dilution may be higher.

2. Discount rates will vary based upon your own personal level of risk tolerance. For example, I might be willing to buy a risky stock if I think I'll earn 10% ...

Solution Summary

The solution explains some finance questions relating to IPO in current economy, discount rates and CAPM for personal decisions. This solution is 860 words.

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