XYZ Corporation has received a firm commitment from its underwriter to purchase

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

Solution:

Direct Expense = (Underwriter's spread * Total Shares) + Legal and Other fees.

Direct Expense

= ($1.90 * 1,000,000) + $1,650,000

= $1,900,000 + $1,650,000

= $3,550,000.

Direct Expense = $3,550,000.

Indirect (Underpricing) Expense = ($27.50 - $23) * 1,000,000 = $4,500,000.

Total Expense = Direct Expense + Indirect Expense

Total Expense = $3,550,000 + $4,500,000 = $8,050,000

Market Value of the Shares = Closing Price * Number of Shares

Market Value of the Shares = $27.50 * 1,000,000 = $27,500,000

Percentage of Direct Expense to Market Value = $3,550,000 / $27,500,000 = 0.1291

Percentage of Indirect Expense to Market Value = $4,500,000 / $27,500,000 = 0.1636

Percentage of Total Expense to Market Value = $8,050,000 / $27,500,000 = 0.2927

Percentage of Direct Expense to Market Value = 12.91%

Percentage of Indirect Expense to Market Value = 16.36%

Percentage of Total Expense to Market Value = 29.27%

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