Chap 15

Question 1

What are some reasons why CFO’s cant make decisions and do analysis?

Answer 1

1. Time
2. Design of a capital investment project involves investment decisions that top managers do not see
3. many capital investments don’t appear in the capital budget
4. small decisions add up
5. the CFO may be subject to the same kinds of temptations that afflict lower layers of management

Question 2

What is the first step in creating a business?

Answer 2

Preparation of a business plan:
-Plan describing the proposed product, its potential market, the underlying technology, and the resources (time, money, employees, and plant and equipment) needed for success.

Question 3

When venture capitalists invest in a start-up, what else do they often demand?

Answer 3

spots on the board of directors, NOT always the majority of seats though

-whether they do depends, for example, on how mature the business is and on what fraction they own. A common compromise gives an equal number of seats to the founders and to outside investors

Question 4

What do start ups often do to raise venture capital?

Answer 4

• give themselves modest salaries
• recognize that in the case of failure, venture capitalists would be first to salvage all assets and they would get nothing

Question 5

How do venture capitalists provide money to start ups?

Answer 5

Multiple stages of financing

Question 6

What are mezzaine investors?

Answer 6

Mezzanine financing does not necessarily come in the third stage; there may be four or five stages.

The point is that mezzanine investors come in late, in contrast to venture capitalists who get in on the ground floor.

Question 7

How do most companies initially raise equity?

Answer 7

• family funds and bank loans

- then move to wealthy individuals called angel investors

Question 8

How do more adolescent companies raise capital?

Answer 8

Venture Capital firms: which pool funds from a variety of investors, seek out fledgling companies to invest in, and then work with these companies as they try to grow

Question 9

What is crowdfunding?

Answer 9

• young companies have also used the Web to raise the money from small investors
• crowdfunded projects simply offer samples of the product in return for investment.

Question 10

How are most venture capital funds organized?

Answer 10

as limited private partnerships with a fixed life of about 10 years

Question 11

Who are limited partners? Who is the general partner?

Answer 11

Pension funds =limited

Management = general

Question 12

What is carried interest?

Answer 12

When management receives a fixed fee and a share of the profits

Question 13

What is private equity investing?

Answer 13

You will find that these venture capital partnerships are often lumped together with similar partnerships that provide funds for companies in distress or that buy out whole companies or divisions of public companies and then take them private

Question 14

Are venture capital firms passive investors?

Answer 14

NO

Question 15

For every 10 first stage venture capital investments, how many survive?

Answer 15

only about 2 or 3

Question 16

What are the two rules for success for venture capitalism ?

Answer 16

1. Don’t shy away from uncertainty; accept a low probability of success. But don’t buy into a business unless you can see the chance of a big, public company in a profitable market.
2. Cut your losses; identify losers early, and if you can’t fix the problem—by replacing management, for example—throw no good money after bad.

Question 17

What is a primary offering vs secondary offering (IPO’s)?

Answer 17

1. Primary offering: new shares are sold to raise additional cash for the company
2. Secondary offering: the existing shareholders decide to cash in by selling part of their holdings.
   - many IPO’s are a mixture

Question 18

Other than raising cash, why else might a company decide to go public?

Answer 18

• stock options
• reduce its borrowing cost.
• to create public shares for use in future acquisitions (MOST COMMON)
• to establish a market price/value for our firm
• to enhance the reputation of our company
• to broaden the base of ownership
• To allow one or more principals to diversify personal holdings
• To minimize our cost of capital
• To allow venture capitalists to cash out
• to attract analysts’ attention
• Our company has run out of private equity
• Debt is becoming too expensive

Question 19

What is a consequence of SOX?

Answer 19

-an increased reporting burden on small public companies and an apparent increase in their readiness to go private.

Question 20

Explain the procedure “going dark”

Answer 20

Companies can alleviate the reporting burden by reducing the number of shareholders to less than 300 and delisting their stock from the exchange.

Question 21

The first step of an IPO is to select underwriters. Explain what their job is.

Answer 21

Usually they play a triple role:

• they provide the company with procedural and financial advice
• then they buy the issue
• finally they resell it to the public.

Question 22

What is a registration statement?

Answer 22

document that presents information about the proposed financing and the firm’s history, existing business, and plans for the future

Question 23

What is a red herring?

Answer 23

The company is allowed to circulate a preliminary version of the prospectus (known as a red herring) before the SEC has approved the registration statement.

Question 24

Who is the book runner?

Answer 24

The managing underwriter

Question 25

What is an all or nothing arrangement?

Answer 25

In this case, either the entire issue is sold at the offering price or the deal is called off and the issuing company receives nothing.

Question 26

What is an all or nothing arrangement?

Answer 26

- In this case, either the entire issue is sold at the offering price or the deal is called off and the issuing company receives nothing - Occasionally, where the sale of common stock is regarded as particularly risky, the underwriters may be prepared to handle the sale only on a best-efforts basis. In this case the underwriters promise to sell as much of the issue as possible, but they do not guarantee to sell the entire amount

Question 27

What is a greenshoe offer?

Answer 27

This ensured that the underwriters were able to sell the extra shares to investors without fear of loss

Question 28

What do underwriters get in return?

Answer 28

-receive payment in the form of a spread; that is, they were allowed to buy the shares for less than the offering price at which the shares were sold to investors

Question 29

Since many of the costs incurred by underwriters are fixed, would expect that the percentage spread would decline with issue size?

Answer 29

Yes

Question 30

What happens if a stock is underpriced at an IPO?

Answer 30

-Since the offering price was less than the true value of the issued securities, investors who bought the issue got a bargain at the expense of the firm’s original shareholders.

Question 31

What does research say about investors who buy at the issue price?

Answer 31

on average they realize very high gains within the next few days

Question 32

Why do investment bankers say underpricing is in the interest of the issuing firm?

Answer 32

They say that a low offering price on an IPO raises the price when it is subsequently traded in the market and enhances the firm’s ability to raise further capital.

Question 33

What is the winners curse?

Answer 33

The highest bidder in an auction is most likely to have overestimated the object’s value and, unless bidders recognize this in their bids, the buyer will on average overpay. If bidders are aware of the danger, they are likely to adjust their bids down correspondingly. -Uninformed investors who cannot distinguish which issues are attractive are exposed to the winner’s curse. Companies and their underwriters are aware of this and need to underprice on average to attract the uninformed investors

Question 34

What is the gray market?

Answer 34

- where the winner’s curse would disappear - only investors knew what the market price was going to be - one response is to allow trading in a security before it has been issued.

Question 35

what is "the money left on the table"?

Answer 35

the difference between the value placed by investors on the stocks and the amount that investors paid for the stocks.

Question 36

What are the 8 steps to an IPO?

Answer 36

1. Company appoints managing underwriter (bookrunner) and co-manager(s). Underwriting syndicate formed. 2. Arrangement with underwriters includes agreement on spread (typically 7% for medium-sized IPOs) and on greenshoe option (typically allowing the underwriters to increase the number of shares bought by 15%). 3. Issue registered with SEC and preliminary prospectus (red herring) issued. 4. Roadshow arranged to market the issue to potential investors. Managing underwriter builds book of potential demand. 5. SEC approves registration. Company and underwriters agree on issue price. 6. Underwriters allot stock (typically with overallotment). 7. Trading starts. Underwriters cover short position by buying stock in the market or by exercising greenshoe option. 8. Managing underwriter makes liquid market in stock and provides research coverage.

Question 37

What is the book building method?

Answer 37

- potential buyers indicate how many shares they are prepared to buy at given prices. - used only as a guide to fix the price of the issue. - it allows underwriters to give preference to those investors whose bids are most helpful in setting the issue price and to offer them a reward in the shape of underpric-ing.

Question 38

What is the book building method?

Answer 38

- potential buyers indicate how many shares they are prepared to buy at given prices. - used only as a guide to fix the price of the issue. - it allows underwriters to give preference to those investors whose bids are most helpful in setting the issue price and to offer them a reward in the shape of underpricing.

Question 39

What happened when all IPO's were auctioned? Then what happened when they went back to the bookbuilding method?

Answer 39

- underpricing went down | - then underpricing went back up

Question 40

What is the difference between discriminatory auction and a uniform-price auction?

Answer 40

Discriminatory: every winner is required to pay the price that he or she bid Uniform Price: bidders both (all) pay lower bid price - provides better protection against the winner’s curse - result in higher proceeds

Question 41

Why do uniform price auctions result in higher proceeds?

Answer 41

because there is little cost to overbidding in a uniform-price auction, but there is potentially a very high cost to doing so in a discriminatory auction

Question 42

How might a financial manager use shelf registration?

Answer 42

- shelf registration: the registration statement is “put on the shelf,” to be taken down and used as needed - a financial manager uses this to issue debt as needed

Question 43

shelf registration is less often used for issues of common stock or convertible securities than for garden-variety corporate bonds.

Answer 43

true. idk what this means

Question 44

What are eurobonds? globalbonds?

Answer 44

- underwritten by a group of international banks and offered simultaneously to investors in a number of countries - Very large debt issues may be sold as global bonds, with one part sold internationally in the eurobond market and the remainder sold in the company’s domestic market.

Question 45

Do larger or smaller issues haver lower spreads?

Answer 45

larger issues have lower spreads

Question 46

How much do announcements of stock issues actually affect stock price?

Answer 46

fall in market value is nearly a third of the new money raised by the issue

Question 47

What may happen if the company decides its stock price is too low?

Answer 47

- could scale back or delay expansion until stock price recovers

Question 48

What may happen if a companys stock is over valued?

Answer 48

- if the firm sells shares at a new high price, it will help existing shareholders at the expense of the new ones

Question 49

Why do companys mark down the price of their stock when an equity issue is announced?

Answer 49

because investors are not stupid and know the company will issue more stocks when they think its share price is higher than it should be

Question 50

Do voluntary or involuntary issues cause a larger drop in stock price?

Answer 50

voluntary because the issue is outside the managers discretion

Question 51

How do financial eonomists interpret the stock price drop on equity issue announcements?

Answer 51

- it is an informational effect | - NOT a result of the additional supply

Question 52

Do pessimistic managers have greater incentive to issue equity or preferred stock/debt?

Answer 52

pessimistic = issue equity

Question 53

Does an announcement of a debt issuance also result in a fall in stock price?

Answer 53

no

Question 54

What is a rights issue?

Answer 54

Offering stock to existing shareholders before issuing to investors at large

Question 55

When is the issue price of a rights offer irrelevant?

Answer 55

When the company successfully sells the new shares

Question 56

General cash offers are typically sold at....?

Answer 56

a discount of about 3% on the previous days closing price - underpricing is not a major worry - this cost can be avoided by using a right issue?

Question 57

What is a private placement?

Answer 57

When a company sells securities privately and therefore avoids the costs of registering with the sec -sold to no more than 35 knowledgeable investors

Question 58

What is a drawback of a private placement?

Answer 58

the investor cannot easily resell the secu- rity. However, institutions such as life insurance companies invest huge amounts in corporate debt for the long haul and are less concerned about its marketability.