Question 5. (15 points) An investment banker enters into a best efforts arrangem

Question

Question 5. (15 points) An investment banker enters into a best efforts arrangement to try and sell 8 million shares of stock at $20 per share for Kemp Corporation. The investment banker incurs expenses of $2.5 million in floating the issue while the company incurs expenses of $1 million. The investment banker will receive 7 percent of the proceeds of the offering.

a. If the offering is successful and sells out at the expected price of $20, how much money will the company receive?

b. If the offering is successful and sells out at the expected price of $20, how much money will the investment banker receive?

c. If the offering is partially successful and 6 million shares are sold at a price of $15, how much does the company receive?

d Same facts as part c. How much does the investment banker receive?

e. Who bears more risk with a best efforts deal, the company or the investment banker? Why?

Explanation / Answer

The investment banker will receive the 7% of proceeds of offering, since it is not clear that what is proceeds of offering it is assumed that the proceeds of offering to mean that money received after the company incurred $1 million and after the investment banker fees i.e.7% on the net cash that the company has received.

A. The amount of cash the company will receive = 8,000,000 * $20 - 1,000,000 - x*0.07 = x

1.07x = 159,000,000

x = 148,598,131

B. The amount that the investment banker will receive = 0.07 * 148,598,131 = 10,401,869

C. Assuming that the investment bankers have not taken undersubscription, The amount of cash the company will receive if the issue is partially successful

6,000,000 * $15 - 1,000,000 - x*0.07 = x

1.07 x = 89,000,000

x = 83,177,570

D. The amount that the investment banker will receive = 0.07 * 83,177,570 = 5,822,430

E. In case of underwriting the Investment banker will take more risk than the company because in the event of undersudscription the investment banker shall undertake the remaining amount of shares. the company risk is limited and it will bear the expenditure only upto the underwriting commission.

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