Pickwick Electronics is a new high-tech compnay financed entirely by $1 million
ID: 2689944 • Letter: P
Question
Pickwick Electronics is a new high-tech compnay financed entirely by $1 million ordinay shares, all of which are owned by Geroge Pickwick. The firm needs to rain $1 miilon now for state 1 and assuming all goes well a futher $1 million at the end of 5 years for stage 2. first cookham venture partner is considering two possible financing schemes: 1. Buying 2 million shares now at teir current valuation of $1. 2. buying 1 million s hares at the currel valuation and investing a futher $1 million at the end of 5 years at whatever the shares are worth. The outlook for Pickwick is uncertain but as long as te compay can secure te additional fiance for statge 2, it will be worth either $2million or 12 millon after completing stage 2. ****QUESTION: show the possible payoffs for Mr. Pickwik and First Cookham and Explain why one schem might be preffered. Assume an inter rate of zeroExplanation / Answer
1 Unless the firm can secure second-stage financing, it is unlikely to succeed. If the entrepreneur is going to reap any reward on his own investment, he needs to put in enough effort to get further financing. By accepting only part of the necessary venture capital, management increases its own risk and reduces that of the venture capitalist. This decision would be costly and foolish if management lacked confidence that the project would be successful enough to get past the first stage. A credible signal by management is one that only managers who are truly confident can afford to provide. However, words are cheap and there is little to be lost by saying that you are confident (although if you are proved wrong, you may find it difficult to raise money a second time).
2 If an investor can distinguish between overpriced and underpriced issues, she will bid only on the underpriced ones. In this case she will purchase only issues that provide a 10 percent gain. However, the ability to distinguish these issues requires considerable insight and research. The return to the informed IPO participant may be viewed as a return on the resources expended to become informed.
3 Direct expenses: Underwriting spread = 69 million Ҥ $4 $ 276.0 million Other expenses 9.2 Total direct expenses $ 285.2 million
Underpricing = 69 million Ҥ ($70 $64) $ 414.0 million Total expenses $ 699.2 million Market value of issue = 69 million Ҥ $70 $4,830.0 million Expenses as proportion of market value = 699.2/4,830 = .145 = 14.5%.
4 Ten issues of $15 million each will cost about 9 percent of proceeds, or .09 Ҥ $150 million = $13.5 million. One issue of $150 million will cost only 4 percent of $150 million, or $6 million.
Pet.Com was founded in 1997 by two graduates of the University of Wisconsin with help from Georgina Sloberg, who had built up an enviable reputation for backing new start-up businesses. Pet.Com`s user-friendly system was designed to find buyers for unwanted pets. Within 3 years the company was generating revenues of $3.4 million a year, and, despite racking up sizable losses, was regarded by investors as one of the hottest new e-commerce businesses. The news that the company was preparing to go public therefore generated considerable excitement.
The company`s entire equity capital of 1.5 million shares was owned by the two founders and Ms. Sloberg. The initial public offering involved the sale of 500,000 shares by the three existing shareholders, together with the sale of a further 750,000 shares by the company in order to provide funds for expansion.
The company estimated that the issue would involve legal fees, auditing, printing, and other expenses of $1.3 million, which would be shared proportionately between the selling shareholders and the company. In addition, the company agreed to pay the underwriters a spread of $1.25 per share.
The road show had confirmed the high level of interest in the issue, and indications from investors suggested that the entire issue could be sold at a price of $24 a share. The underwriters, however, cautioned about being too greedy on price. They pointed out that indications from investors were not the same as firm orders. Also, they argued, it was much more important to have a successful issue than to have a group of disgruntled shareholders. They therefore suggested an issue price of $18 a share.
That evening Pet.Com`s financial manager decided to run through some calculations. First she worked out the net receipts to the company and the existing shareholders assuming that the stock was sold for $18 a share. Next she looked at the various costs of the IPO and tried to judge how they stacked up against the typical costs for similar IPOs. That brought her up against the question of underpricing. When she had raised the matter with the underwriters that morning, they had dismissed the notion that the initial day`s return on an IPO should be considered part of the issue costs. One of the members of the underwriting team had asked: ¬The underwriters want to see a high return and a high stock price. Would Pet.Com prefer a low stock price? Would that make the issue less costly? Pet.Com`s financial manager was not convinced but felt that she should have a good answer. She wondered whether underpricing was only a problem because the existing shareholders were selling part of their holdings. Perhaps the issue price would not matter if they had not planned to sell.