Use the following information to answer the question(s) below.
Wyatt Oil has 8 million shares outstanding and is about to issue 10 million new shares in an IPO. The IPO price has been set at $15 per share, and the underwriting spread is 6%. The IPO is a big success with investors, and the share price rises to $35 the first day of trading.
-The total cost to the firm's original investors due to the market imperfections from the IPO is closest to:

Question

Quizplus · Accepted Answer

B) If Wyatt went with the investment banker it would have a total of 10 + 8 = 18 million shares outstanding after the IPO. Each of these shares is worth $35 per share for a total value of 18 million x $35 = $630 million. Also if Wyatt used the underwriter it would have issued 10 million shares at $15 per share for a total of $150 million. However the underwriter would take the 6% underwriting spread or 6% x $150 = $9 million leaving only $141 million for Wyatt Oil. Okay, now we need to solve for both the number of new shares issued and the price per share using this information assuming perfect capital markets. The market value of Wyatt after the IPO and the total capital raise give us the following two equations and two unknowns:
MV = (8 million existing shares + N new shares) x new stock price => (8 + N)P = 630
Amount raised = N new shares x new stock price => NP = $141 => N = 141/P
Now we substitute N = 141/P into the first equation giving us
(8 + 141/P)P = 630 => 8P + 141 = 630 => 8P = 489 => P = $61.125
So the total cost original investors is ($61.125 - $35) x 8 million shares = $209 million

Use the Following Information to Answer the Question(s) Below