Problems

Ebay, Inc. went public in September of 1998. The following information on shares outstanding was
listed in the final prospectus filed with the SEC1.
In the IPO, the Ebay issued 3,500,000 new shares. The initial price to the public was $18.00 per share.
The final first-day closing price was $44.88.
1. If investment bankers retained $1.26 per share as fees, what was the net proceeds to Ebay? What
was the market capitalization of new shares of Ebay?
- Net Proceeds = (18 – 1.26) x 3,500,000 = 58.59 millions
- Market Capitalization = 44.88 x 3,500,000 = 157.08 millions

2. Two common statistics in IPOs are underpricing and money left on the table. Underpricing is
defined as percentage change between the offering price and the first day closing price. Money
left on the table is the difference between the first day closing price and the offering price,
multiplied by the number of shares offered. Calculate the underpricing and money left on the
table for Ebay. What does this suggest about the efficiency of the IPO process?

- Underpricing = (44.88 - 18)/18 = 1.493 = 149.3%

- Money left on the table = (44.88 – 18) x 3,500,000 = 94.08 millions

 eBay left over $100 million on the table, meaning the company could have raised that much more if
it had priced the IPO closer to actual demand

 In short, while underpricing can generate positive PR and ensure a successful launch, it often
comes at a high cost to the issuing company

 Not very efficient

3. The shares of Misheak, Inc. are expected to generate the following possible returns over the next
12 months:

Return Probability
-5% 0.10
5% 0.25
10% 0.30
15% 0.25
25% 0.10

If the stock is currently trading at $25/share, what is the expected price in one year. Assume that
the stock pays no dividends.
- Expected Return = 0.1 = 10%
- Expected Price = 25 x (1+0.1) = 27.5

4. Sine Corp. stock sells for $75.00 and currently

- Price = 74.75

5. Suppose Microsoft, Inc. was trading at $27.29 per share. At that time, it pays an annual dividend
of $0.32 per share, and analysts have set a 1-year target price around $33.30 per share. What is
the expected return on this stock?
1
This information is summarized from http://www.sec.gov/Archieves/edgar/data/1065088/0001012870-98-002475.txt
- Expected Return = 0.232 = 23.2%

- Dividend Yield = 0.32/27.29 = 1.17%

 Capital Gain Yield = 23.2% - 1.17%

6. LaserAce is selling at $22.00 per share. The most recent annual dividend paid was $0.80. Using
the Gordon Growth model, if the market requires a return of 11%, what is the expected dividend
growth rate for LaserAcer?

- DIV1 = DIV0 x (1 + g)

Price = 0.071 = 7.1%

7. ANCAP Oil Co. stock has a PE ratio equal to 22, whereas VRC Oil has a PE ratio equal to 20.
Both firms´ earnings per share are $1.12. Calculate both firms´
stock prices.

- Price (Ancap) = 22 x 1.12 = 24.64

- Price (Vrc) = 20 x 1.12 = 22.4

8. Refer to the previous exercise. Calculate the premium paid by investors to hold ANCAP Oil Co.
shares instead of VRC Oil. Which company do you think is a safer investment?

- delta = (24.64 – 22.4)/22.4 = 10%  premium < 10%

- VRC is a safer investment due to low PE  Not overpriced or higher earnings

9. Gordon & Co.’s stock has just paid its annual dividend $1.10 per share. Analysts believe that
Gordon will maintain its historic dividend growth rate of 3%. If the required return is 8%, what is
the expected price of the stock next year?

- Calculate Div1 = Div0 x (1 + g) ; P1 = Div2 / (ke – g)

10. Macro Systems just paid an annual dividend of $0.32 per share. Its dividend is expected to double
for the next four years (D1 through D4), after which it will grow at a more modest pace of 1% per
year. If the required return is 13%, what is the current price?

- (1  4) g = 100%

- (4  end) g = 1%

- r = 13%

- Price = 32.91

11. Nat-T-Cat Industries just went public. As a growing firm, it is not expected to pay a dividend for
the first five years. After that, investors expect Nat-T-Cat to pay an annual dividend $1.00 per
share (i.e., D6 = 1.00), with no growth. If the required return is 10%, what is the current stock
price?

- Price = 6.21

12. Calculate the stock price of OSE Water Co. if the difference between the required rate of return
on this investment and the expected growth rate of dividends is 3.6% and dividends per share are
$1.728.

- Price = 48

13. Refer to the previous exercise. What is the implicit required rate of return if dividends are
expected to grow at a 5% annual rate?

- Rate of return = 5% + 3.6% = 8.6%