Deck 15: How Firms Raise Capital

Question 1

With a firm-commitment underwriting, the investment banking firm makes no guarantee to sell the securities at a particular price.

Answer 1

False

Question 2

Traditional sources of funding, such as from financial and insurance firms, work for new or emerging businesses despite the presence of only intangible assets.

Answer 2

False

Question 3

The process by which many entrepreneurs raise seed money and obtain other resources necessary to start their businesses is often called bootstrapping.

Answer 3

True

Question 4

In the firm-commitment underwriting, which is more typical, the investment banker guarantees the issuer a fixed amount of money from the stock sale.

Question 5

Privately held firms find it easier to attract top management talent and to better motivate current managers.

Question 6

A principal way for venture capitalists to exit is to sell part of the firm's equity back to the entrepreneur.

Question 7

To complete an IPO, a firm will need the services of angel investors, who are experts in bringing new securities to market.

Question 8

The amount of equity capital that can be raised in the public equity markets is typically smaller than the amount that can be raised through private sources.

Question 9

Venture capitalists are individuals or firms that help privately held businesses by providing funds in the bootstrapping process.

Question 10

The key idea behind staged funding is that each funding stage gives the venture capitalist an opportunity to reassess the management team and the firm's financial performance.

Question 11

Underwriting is the risk-bearing part of investment banking.

Question 12

The initial seed money usually comes from the entrepreneur or other founders.

Question 13

A significant number of venture capital firms focus on high-technology investments.

Question 14

Angel investors are investors who come to the rescue of firms threatened by takeovers.

Question 15

A significant number of venture capital firms focus on mature businesses.

Question 16

The bootstrapping period usually lasts for at least five years.

Question 17

Most businesses are started when an entrepreneur is given seed funding by institutional investors.

Question 18

To complete an IPO, a firm will need the services of investment bankers, who are experts in bringing new securities to market.

Question 19

A venture capitalist may exit an investment by selling common stock in an initial public offering.

Question 20

In a best-effort offering, the underwriter promises to make its "best effort" to sell all securities at a certain price.

Question 21

Which of the following statements is NOT true?

A) Venture capitalists often require an entrepreneur to make a substantial personal investment in the business.
B) Syndication occurs when the originating venture capitalist buys off other venture capitalists involved in the venture.
C) Another factor that reduces risk is the venture capitalist's in-depth knowledge of the industry and technology.
D) The key idea behind staged funding is that each funding stage gives the venture capitalist an opportunity to reassess the management team and the firm's financial performance.

Question 22

PIPE transactions refer to transactions in which a public company sells unregistered stock to a hedge fund or some other institutional investor..

Question 23

Tactics that venture capitalists use to reduce the risk of their investment include

A) funding the ventures in stages, requiring entrepreneurs to take charge of all important business decisions.
B) funding the ventures completely in the beginning, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize.
C) funding the ventures in stages, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize.
D) None of the above

Question 24

Underpricing is defined as offering new securities for sale at a price below their true value.

Question 25

Which of the following statements is true?

A) The venture capital industry as we know it today emerged in the late 1960s with the formation of the first venture capital limited partnerships.
B) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices.
C) A significant number of venture capital firms focus on high-technology investments.
D) All of the above statements are true.

Question 26

Term loans are defined as business loans with maturities greater than one month but less than one year.

Question 27

In a firm-commitment offering, the underwriters will suffer a financial loss if the offer price is set too high.

Question 28

Provisions that are part of venture capital agreements include

A) timing of exit, number of board positions after exit, and what price is acceptable.
B) timing of exit, the method of exit, and what price is acceptable.
C) the method of exit, number of board positions after exit, and what price is acceptable.
D) None of the above

Question 29

Bootstrapping is the process by which

A) many entrepreneurs raise seed money and obtain other resources necessary to start their businesses.
B) the entrepreneur often fleshes out his or her ideas and makes them operational.
C) most businesses are started by an entrepreneur.
D) None of the above

Question 30

If the offer price is set too high, the issuing firm will lose under a best-effort agreement.

Question 31

The biggest drawback of private placements involves restrictions on the resale of the securities.

Question 32

Private placement occurs when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals.

Question 33

A typical venture capital fund may generate annual returns of

A) 15 to 25 percent on the money that it invests, compared with an average annual return for the S&P 500 of almost 12 percent.
B) 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 20 percent.
C) 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 25 percent.
D) None of the above

Question 34

The major disadvantage of a PIPE transaction to issuers is that the funding cost is higher as compared to making a public offer.

Question 35

Bootstrapping and venture capital financing are part of the public market operations of a business.

Question 36

Which of the following statements is NOT true?

A) Venture capitalists bear a substantial amount of risk when they fund a new business.
B) Venture capitalists' sole function is to provide financing for new firms.
C) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices.
D) A significant number of venture capital firms focus on high-technology investments.

Question 37

Which of the following statements is NOT true?

A) The process by which many entrepreneurs raise seed money and obtain other resources necessary to start their businesses is often called bootstrapping.
B) Most businesses are started by an entrepreneur who has a vision for a new business or product and a passionate belief in the concept's viability.
C) The initial "seed" money usually comes from the entrepreneur or other founders.
D) The seed money is spent on developing an initial public offering.

Question 38

The three principal ways in which venture capital firms exit venture-backed companies are

A) selling to a strategic buyer, buying out the founder, and offering stock to the public.
B) selling to a strategic buyer, selling to a financial buyer, and buying out the founder.
C) selling to a strategic buyer, selling to a financial buyer, and offering stock to the public.
D) None of the above

Question 39

A general cash offer is a sale of debt or equity, open to all investors, by a registered public company that has previously sold stock to the public.

Question 40

The initial seed money for a start-up usually comes from

A) public investors.
B) investment banks.
C) the entrepreneur or other founders.
D) commercial banks.

Question 41

Fortune Hotels issues an IPO on a best-effort basis. The company's investment bank requires a spread of 20 percent of the selling price. Five million shares are issued. The average selling price is expected to be $31. What are the net proceeds per share for the issuer?

A) $27.50
B) $22
C) $31
D) $24.8

Question 42

Pau, Inc. issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the underwriting cost?

A) $13.6 million
B) $20.6 million
C) $6.94 million
D) None of the above

Question 43

Pau, Inc. issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the underpricing cost of issuing the securities to the firm? (Round your intermediate calculations to two decimal places.)

A) $13.60 million
B) $20.60 million
C) $6.94 million
D) $7.57 million

Question 44

Bethesda Biosys issues an IPO on a best-efforts basis. The company's investment bank requires a spread of 18 percent of the selling price. The average selling price is expected to be $25 per share. Four million shares are issued. What are the net proceeds for the issuer?

A) $82 million
B) $92 million
C) $100 million
D) None of the above

Question 45

With a best-effort underwriting,

A) the investment banking firm makes no guarantee to sell the securities at a particular price.
B) the investment banker does not bear the price risk associated with underwriting the issue.
C) the compensation is based on the number of shares sold.
D) All of the above

Question 46

Basic services provided by investment bankers bringing securities to market include

A) origination.
B) underwriting.
C) distribution.
D) All of the above

Question 47

Which of the following statements is NOT true?

A) In a best-effort offering, the underwriters will suffer a financial loss if the offer price is set too high.
B) In a best-effort agreement, the issuing firm will lose if the offer price is set too high.
C) If the underpricing is significant, the investment banking firm will suffer a loss of reputation for failing to price the new issue correctly and raising less money for its client than it could have.
D) Underpricing is defined as offering new securities for sale at a price below their true value.

Question 48

Stump, Inc. issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day. What is the underpricing on this issue?

A) $9,900,000
B) $24,900,000
C) $15,000,000
D) None of the above

Question 49

Which of the following statements is true?

A) After the IPO, there is a less active secondary market for the firm's shares.
B) Only smaller amounts of capital can be raised through an IPO than the amount that can be raised through private sources.
C) Publicly traded firms find it easier to attract top management talent.
D) Going public can enable an entrepreneur to fund a growing business but not without giving up control.

Question 50

Fortune Hotels issues an IPO on a best-effort basis. The company's investment bank requires a spread of 20 percent of the selling price. Five million shares are issued. The average selling price is expected to be $31. How much did the investment bank receive?

A) $22.0 million
B) $27.5 million
C) $31.0 million
D) None of the above

Question 51

Advantages of going public include all EXCEPT

A) larger amount of capital can be raised this way than the amount that can be raised through private sources.
B) the cost of going public is less compare to debt financing.
C) going public can enable an entrepreneur to fund a growing business without giving up control.
D) additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost.

Question 52

Stump, Inc. issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day. What is the firm's total cost of issuing the securities?

A) $24.9 million
B) $15.35 million
C) $25.25 million
D) None of the above

Question 53

The three costs associated with issuing stock in an IPO are

A) price premium, out-of-pocket expenses, and underpricing.
B) underwriting spread, out-of-pocket expenses, and underpricing.
C) underwriting spread, price premium, and underpricing.
D) None of the above

Question 54

Stump, Inc. issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day. What is the underpricing spread?

A) $51 million
B) $15 million
C) $66 million
D) None of the above

Question 55

All of the following about a firm-commitment underwriting is true EXCEPT

A) the investment banker guarantees the issuer a fixed amount of money from the stock sale.
B) the investment banker actually buys the stock from the firm.
C) the issuer bears the risk that the resale price might be lower than the price the underwriter pays.
D) the underwriter bears the risk that the resale price might be lower than the price the underwriter pays.

Question 56

Pau, Inc. issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the total cost of issuing the securities to the firm?

A) $13,606,000
B) $20,818,000
C) $20,610,000
D) None of the above

Question 57

Which of the following statements is NOT true?

A) Investment bankers provide three basic services when bringing securities to market-origination, underwriting, and distribution.
B) During the origination phase, the investment banker helps the firm determine whether it is ready for an IPO.
C) Origination is the risk-bearing part of investment banking.
D) Origination includes giving the firm financial advice and getting the issue ready to sell.

Question 58

Disadvantages of going public include all EXCEPT

A) managers' tendency to focus on long-term profits.
B) the high cost of the IPO itself.
C) the costs of complying with ongoing SEC disclosure requirements.
D) the transparency that results from this compliance can be costly for some firms.

Question 59

Data from the marketplace show that the shares sold in an IPO are typically

A) priced between 2 and 5 percent below the price at which they close at the end of the first day of trading.
B) priced between 10 and 15 percent above the price at which they close at the end of the first day of trading.
C) priced between 10 and 15 percent below the price at which they close at the end of the first day of trading.
D) priced between 2 and 5 percent above the price at which they close at the end of the first day of trading.

Question 60

When Geo Corp. went public in September 2008, the offer price was $19.00 per share and the closing price at the end of the first day was $24.70. The firm issued 4 million shares. What was the loss to the company due to underpricing?

A) $13.6 million
B) $20.83 million
C) $20.6 million
D) $22.8 million

Question 61

Which of the following statements is NOT true?

A) Private placement occurs when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals.
B) In private placements, there are no restrictions on the resale of the securities.
C) About half of all corporate debt is sold through the private placement market.
D) Investment banks and money center banks often assist firms with private placements.

Question 62

Private equity firms improve the performance of firms in which they invest by:

A) making sure that the firms have the best possible management teams.
B) closely monitoring each firm's performance and providing advice and counsel to the firm's management team.
C) facilitating mergers and acquisitions that help improve the competitive positions of the companies in which they invest.
D) All of the above are correct.

Question 63

Which of the following statements is true of PIPE transactions?

A) Under federal securities law, they can be resold to investors in the public markets immediately even if they are not registered.
B) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC, usually within 90 days of the PIPE closing.
C) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC after 90 days of the PIPE closing.
D) PIPE transactions involving a healthy firm can also be executed without the use of an investment bank but result in a cost increase of 7 to 8 percent of the proceeds.

Question 64

Benefits from shelf registration include all EXCEPT

A) greater flexibility in bringing securities to market.
B) the ability for firms to periodically sell small amounts of securities and raise capital as needed.
C) a shelf registration statement can cover multiple securities, but there is a penalty if authorized securities are not issued.
D) costs associated with selling the securities are reduced because only a single registration statement is required.

Question 65

The most likely reason that underpricing of new issues occurs more frequently than overpricing is the:

A) Underwriters' desire to reduce the risk of a firm commitment.
B) Demand for a new issue is typically too high.
C) Underwriters earn low rates of return.
D) Issuing firms demand that equity be underpriced.

Question 66

Which of the following statements is NOT true of PIPE transactions?

A) PIPE transactions are registered with the SEC.
B) PIPE transaction gives issuers faster access to capital.
C) In a PIPE transaction, investors purchase securities (equity or debt) directly from a publicly traded company in a private placement.
D) The securities are virtually always sold to the investors at a discount to the price at which they would sell in the public markets.

Question 67

Castle Co. needs to borrow $10 million for process improvement upgrades. Management decides to sell 20-year bonds. They determine that the 3-month Treasury bill rate is 2.75 percent, the firm's credit rating is A, and the yield on 20-year Treasury bonds is 1.80 percent higher than that for 3-month Treasury bills. Bonds with an A rating are selling for 50 basis points above the 20-year Treasury bond rate. What is the loan rate for this transaction?

A) 4.55%
B) 5.05%
C) 7.75%
D) 9.55%

Question 68

Which of the following statements is NOT true?

A) For firms that have limited access to the public capital markets, the cheapest source of external funding is often the private markets.
B) Bootstrapping and venture capital financing are not part of the private market.
C) The biggest drawback of private placements involves restrictions on the resale of the securities.
D) Many private companies that are owned by entrepreneurs, families, or family foundations and are sizable companies of high credit quality prefer to sell their securities in the private markets.

Question 69

Dienz Pharma plans to issue an IPO on a best-effort basis. The company's investment bank requires a spread of 16 percent of the selling price. The selling price is $32 per share. Three million shares are issued. What are the proceeds for the issuer?

A) $96.00 million
B) $78.75 million
C) $80.64 million
D) None of the above

Question 70

A firm is making an initial public offering. The investment bankers agree to a firm underwriting commitment of 500,000 shares priced to the public at $50 a share. The underwriter's spread is 12%. In addition, the underwriter charges $600,000 in legal fees. On the first day of trading, the firm's stock closed at $61. What were the total costs of the issue?

A) $3,000,000
B) $3,600,000
C) $8,500,000
D) $9,100,000

Question 71

Suppose two firms want to borrow money from a bank for a period of 10 years. Firm A has excellent credit and can borrow at the prime rate, whereas Firm B's credit standing is prime rate plus 2 percent. The current prime rate is 5.75 percent, the 30-year Treasury bond yield is 4.35 percent, the three-month Treasury bill yield is 3.54 percent, and the 10-year Treasury note yield is 4.24 percent. What are the appropriate loan rates for both the firms?

A) 6.45% for Firm A, 7.75% for Firm B
B) 6.45% for Firm A, 8.45% for Firm B
C) 5.75% for Firm A, 8.45% for Firm B
D) None of the above

Question 72

Which of the following statements is NOT true?

A) Private equity firms pool money from wealthy investors, pension funds, insurance companies, and other sources to make investments.
B) Private equity firms invest in more mature companies.
C) Agency problems tend to be more in firms owned by private equity investors than in public firms.
D) Private equity investors focus on firms that have stable cash flows because they use a lot of debt to finance their acquisitions.

Question 73

Marigold Corp. wants to borrow money from Howard Bank for a period of five years. The firm's credit standing calls for a premium of 1.5 percent over the prime rate. The current prime rate is 6.5 percent, the 30-year Treasury bond yield is 5.375 percent, the three-month Treasury bill yield is 3.525 percent, and the 5-year Treasury note yield is 4.25 percent. What is the appropriate loan rate for this customer?

A) 8.725%
B) 7.225%
C) 6.500%
D) None of the above

Question 74

Why is the total cost of bringing a general cash offer to the market lower than an IPO?

A) General cash offer does not include a large underpricing
B) Underwriting spreads are smaller in case of general cash offer
C) There is less risk involved with a general cash offer than an IPO
D) All of the above

Question 75

Which of the following statements is NOT true of shelf registration?

A) Shelf registration gives firms less flexibility in bringing securities to market.
B) During a two-year window, the firm can take the securities "off the shelf" and sell them as needed.
C) Shelf registration allows firms to periodically sell small amounts of securities.
D) A shelf registration statement can cover multiple securities, and there is no penalty if authorized securities are not issued.

Question 76

Star Corporation, an auto fuel cell maker, is planning a new plant and needs to raise $30 million to finance it. The company plans to raise the money through a general cash offering priced at $23.50 a share. Star's underwriters charge a 6 percent spread. How many shares does the company need to sell to achieve its goal? (Round your final answer to the nearest unit of share.)

A) 1,358,081 shares
B) 1,276,596 shares
C) 1,200,000 shares
D) None of the above

Question 77

Jasper, Inc. is looking for a five-year term loan of $3 million. The firm will have to pay a premium of 1.5 percent for default risk to its bank and another 0.75 percent for maturity risk. The current prime rate is 7.5 percent. What is the loan rate on this bank loan?

A) 9%
B) 8.25%
C) 9.75%
D) None of the above

Question 78

Why do traditional sources of funding not work for new or emerging businesses?

Question 79

Advantages of private placements include

A) lower cost of funds.
B) more willingness among private lenders to negotiate changes to a bond contract.
C) the speed of private placement deals and flexibility in issue size.
D) All of the above

Question 80

Which of the following statements is NOT true?

A) In a competitive sale, the firm specifies the type and amount of securities it wants to sell.
B) In a negotiated sale, the issuer selects the underwriter at the beginning of the origination process.
C) In a general cash offer, management must decide whether to sell the securities on a competitive or a negotiated basis.
D) For equity securities, competitive sales generally provide the lowest-cost method of sale.