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Initial Public Offering and Flotation Costs

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1. IPO Underpricing. The James Co/and the Lars Co. have both announced IPOs at $30 per share. One of these is undervalued by $6, and the other is overvalued by $3, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled. If you could get 1,000 shares in James and 1,000 shares in Lars, what would your profit be? What profit do you actually expect? What principle have you illustrated?

2. Calculating Flotation Costs. The Clapper Corporation needs to raise $60 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. If the offer price is $75 per share and the company's underwriters charge a 7 percent spread, how many shares need to be sold?

5. Calculating Flotation Costs. The Moser Corporation needs to raise $35 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. If the offer price is $42 per share and the company's underwriters charge a 6 percent spread, how many shares need to be sold?

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The solution answers three questions related to IPO Underpricing and the number of shares that need to be sold given the amount needed and the floatation cost

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1. IPO Underpricing. The James Co/and the Lars Co. have both announced IPOs at $30 per share. One of these is undervalued by $6, and the other is overvalued by $3, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled. If you could get 1,000 shares in James and 1,000 shares in Lars, what would your profit be? What profit do you actually expect? What principle have you illustrated?

Profit actually received
Offer price Actual value No applied for No allotted Price paid for Value of holding
Over priced issue 30 27 1000 1000 30000 27000
Underpriced issue 30 36 1000 500 15000 18000
45000 45000

Profit actually ...

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