Chapter 15 Question 1: Moonscape Has Just Completed An Initi
Chapter 15 Question 1 Moonscape Has Just Completed An Initial Public
Moonscape has just completed an initial public offering (IPO). The company sold 1 million shares at an offer price of $10 per share. The underwriting spread was $0.70 per share. The stock closed at $15 per share at the end of the first day of trading. Additionally, the firm incurred $100,000 in legal, administrative, and other costs.
Calculate the flotation costs as a fraction of the funds raised. Express your answer as a percentage rounded to two decimal places. Do not round intermediate calculations.
Sample Paper For Above instruction
The process of going public through an initial public offering (IPO) involves several costs that can impact the net funds raised by a company. In the case of Moonscape, the key elements include the offer price, underwriting spread, closing market price, and ancillary costs such as legal and administrative expenses. To determine the flotation costs as a percentage of the funds raised, it is essential to accurately account for all associated costs and compare them to the gross proceeds from the offering.
First, let's analyze the funds raised from the IPO. The company sold 1 million shares at an offer price of $10 per share, gross proceeds being $10 million. However, the underwriting spread, which is the fee paid to underwriters for their services, was $0.70 per share. Therefore, the gross amount received by the company before other expenses is calculated as:
Gross proceeds = Number of shares issued × Offer price = 1,000,000 × $10 = $10,000,000
Underwriting costs = Number of shares × Underwriting spread = 1,000,000 × $0.70 = $700,000
Remaining proceeds after underwriting (before other costs) = Gross proceeds – Underwriting costs = $10,000,000 – $700,000 = $9,300,000
Next, consider the closing market price at $15 per share. While this reflects the trading performance, the proceeds from the initial offering are based on the offer price, not the closing market price. The product of the number of shares and the offer price gives the total amount initially raised before any costs or the stock's subsequent trading performance.
Additional costs include legal, administrative, and other expenses totaling $100,000. These are direct costs associated with the IPO process, decreasing the net amount received by the company.
Total costs = Underwriting costs + Legal and administrative costs = $700,000 + $100,000 = $800,000
Net proceeds = Gross proceeds – total costs = $10,000,000 – $800,000 = $9,200,000
The total flotation costs are calculated as the sum of all costs divided by the gross proceeds, which effectively represents the fraction of funds lost due to issuance costs. To express this as a percentage:
Flotation costs percentage = (Total costs / Gross proceeds) × 100 = ($800,000 / $10,000,000) × 100 = 8.00%
Hence, the flotation costs as a fraction of funds raised are exactly 8.00%, which significantly influences the company's capital raising efficiency and future valuation considerations.
References
- Brealey, R. A., Myers, S. C., & Marcus, A. J. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education.
- Ehrhardt, M. C., & Brigham, E. F. (2019). Corporate Financial Management (4th ed.). Cengage Learning.
- Ross, S. A., Westerfield, R., & Jaffe, J. (2018). Corporate Finance (12th ed.). McGraw-Hill Education.
- Damodaran, A. (2015). Applied Corporate Finance (4th ed.). John Wiley & Sons.
- Levy, H., & Sarnat, M. (2020). Investments & Portfolio Management. Pearson Education.
- Copeland, T., Weston, J. F., & Shastri, K. (2005). Financial Theory and Corporate Policy (4th ed.). Pearson.
- Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management (15th ed.). Cengage Learning.
- Franklin, M., & Dev, D. (2017). Introduction to Liquidity and Capital Markets. Wiley Finance Series.
- Fischer, C., & Roncaglia, J. (2016). Corporate Financial Strategy. Routledge.
- Higgins, R. C. (2018). Analysis for Financial Management. McGraw-Hill Education.