XYZ Corporation has received a firm commitment from its underwriter to purchase
ID: 2624537 • Letter: X
Question
XYZ Corporation has received a firm commitment from its underwriter to purchase 1 million shares of stock that will be marketed to the general public at $23 per share. The underwriter's spread is $1.90 per share and the issuing firm will pay an additional $1.65 million in legal and other fees. The issue was fully sold on the first day and the stock closed at $27.50 on that day. Calculate both the direct expense of issuance and the indirect (i.e., underpricing) expense. What percentage of the market value of the shares is represented by these costs?
Explanation / Answer
Direct expense = (number of shares * underwriter's spread) + legal fees
= (1,000,000 * 1.90) + 1,650,000 = 3,550,000
Indirect expense = number of shares * (closing price - selling price)
= 1,000,000 * (27.50 - 23) = 4,500,000
Total expense = 3,550,000 + 4,500,000 = 8,050,000
% of market value = total expense / (number of shares * closing price)
= 8,050,000 / (1,000,000 * 27.50) = 29.27%
Answer: Direct expense = 3,550,000, Indirect expense = 4,500,000, and % of market value = 29.27%
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