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 one 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 one 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.
The income to the investment banker is
1. The fee now which is ...
The solution explains how to calculate the present value of the total underwriting compensation.