Chapter 20

1.
The first equity issue offered to the general
public by a firm is a:

A.
B.
C.
D.
E.

2. An equity issue sold to the firm's existing

stockholders is called a:

A.
B.
C.
D.
E.

3. Management's first step in any issue of

securities to the public is to:

A.
B.
C.
D.
E.

4. The first public equity issue offered by a

company is commonly referred to as a(n):

A.
B.
C.
D.
E.
5. An equity issue up to $1 million offered in
small increments to a large number of
people via the Internet is most commonly
referred to as:

A.
B.
C.
D.
E.

6. The green shoe provision is used to:

A.
B.
C.
D.
E.

7. Dilution commonly refers to the:

A.
B.
C.
D.
E.

8. A preliminary prospectus contains:

A.
B.
C.
D.
E.
9. A company must file a registration
statement with the SEC providing various
financial and company information in order
to sell new securities to the public. This
registration statement does not need to be
filed if the:

A.
B.
C.
D.
E.

10. Security issues that are governed by

Regulation A are:

A.
B.
C.
D.
E.

11.
Potential investors primarily obtain detailed
information regarding a new issue by
reading the:

A.

B.

C.
D.
E.
12. A registration statement is effective on the
20th day after filing unless:

A.
B.
C.
D.
E.

13. A firm commitment arrangement with an

investment banker occurs when the:

A.
B.
C.
D.
E.

14. Which one of the following services is least

apt to be offered to a corporation by an
investment bank?

A.
B.
C.
D.
E.

15. In a best efforts offering the investment

bank makes its money primarily by earning:

A.
B.
C.
D.
E.
16. Under the _______ method, the underwriter
buys the securities for less than the offering
price and accepts the risk of not selling the
issue, while under the _______ method, the
underwriter does not purchase the shares
but merely acts as an agent.

A.
B.
C.
D.
E.

17. Empirical evidence suggests that new equity

issues are generally:

A.
B.
C.
D.
E.

18. Negotiated offers generally:

A.
B.
C.
D.
E.

19. Venture capitalists are:

A.
B.
C.
D.
E.
20. Empirical evidence suggests that upon
announcement of a seasoned equity issue,
current stock prices generally:

A.
B.
C.
D.
E.

21. Debt capacity is often offered as a reason

for a stock price to decline when additional
equity securities are issued. The primary
reason that supports this argument is that:

A.
B.
C.
D.
E.

22. Direct expenses of an IPO include the:

A.
B.
C.
D.
E.

23. In comparison to debt issuance expenses,

the total direct costs of equity issues are:

A.
B.
C.
D.
E.
24. To determine the value of a rights offering,
the stockholder needs to know the following
two pieces of information in addition to the
current stock price, the:

A.
B.
C.
D.
E.

25. Assuming everything else is constant, when

a stock goes ex-rights the stock price
should:

A.
B.
C.
D.
E.

26. If current shareholders want to acquire one

share of stock under a rights plan they
must:

A.
B.
C.
D.
E.

27. Which one of the following statements is

true concerning a rights offering?

A.
B.
C.
D.
E.
28. Shareholders who have rights are always:

A.
B.
C.
D.
E.

29. A standby underwriting arrangement in

conjunction with a rights offering provides
the:

A.
B.
C.
D.
E.

30. In a typical deal, the venture capitalist will

receive at least ______ percent of the equity
of financed firm.

A.
B.
C.
D.
E.

31. Corporations primarily use the shelf

registration method of security sales
because:

A.
B.
C.
D.
E.

32. Venture capitalists will frequently:

A.
B.
C.
D.
E.
33. Arguments offered as explanations, with or
without market evidence, as to why most
U.S. equity issues are sold without rights
include all of the following except:

A.
B.
C.
D.
E.

34. All of the following are major requirements

needed to qualify for shelf registration
except:

A.
B.
C.
D.
E.

35. One argument against the use of shelf-

registration is:

A.
B.
C.
D.
E.

36. The market for venture capital refers to the:

A.
B.
C.
D.
E.
37. Venture capitalists provide financing for new
firms from the seed and start-up stage all
the way to mezzanine and bridge financing.
In exchange for this financing, venture
capitalists generally receive:

A.
B.
C.
D.
E.

38. Which one of the following is not one of the

four main functions provided by
underwriters?

A.
B.
C.
D.
E.

39. Which type(s) of dilution are relevant to a

firm’s shareholders when the firm’s shares
are issued with rights?

A.
B.
C.
D.
E.
40.
Dream Makers has expended almost all of
its start-up funds and is seeking venture
capital to begin manufacturing. Which type
of financing is it seeking?

A.

B.

C.

D.

E.
41.
The price at which offered securities are
sold in a Dutch auction underwriting is
determined by the:

A.

B.

C.

D.

E.

42.
Green Shoe options generally last ____ days
and benefit ____.

A.

B.

C.

D.

E.
43.
Which one of these applies to the after
market period?

A.

B.

C.

D.

E.

44.
Oversubscription is most commonly the
result of:

A.

B.

C.

D.

E.
45.
Which type of offering will generally incur
the lowest direct issue costs as a
percentage of gross proceeds?

A.

B.

C.

D.

E.

46.
Which one of these characteristics is least
applicable to term loans?

A.

B.

C.

D.

E.
47.
Which one of these statements related to
debt financing is correct?

A.

B.

C.

D.

E.

48. The Wordsmith Corporation has 40,000

shares outstanding with a market price of
$25 each. The firms expects to raise
$200,000 via a rights offering at a
subscription price of $20. How many rights
must be submitted to acquire one new
share?

A.
B.
C.
D.
E.
49. Assume it requires 3 rights to obtain a new
share in a rights offering. If the stock's price
prior to the ex-rights date is $25 and the ex-
rights price is $22.75, what is the value of
each right?

A.
B.
C.
D.

E.

50. You own 200 shares of a stock valued at $21

a share. Each share is entitled to one right.
A rights offer grants you the option of
obtaining one new share for two rights plus
$17. What is the value of each right?

A.
B.
C.
D.
E.

51. Regional Power wants to raise $2.4 million in

new equity via a rights offering with a
subscription price of $12. There are
currently 2.6 million shares outstanding,
each with one right. How many rights are
needed to purchase one new share?

A.
B.
C.
D.
E.
52. Western Markets has 150,000 shares
outstanding with a market price per share of
$15. Each share is entitled to one right. If
the firm sets a rights offer as 5 rights plus
$10 for each new share, what will be the ex-
rights price per share?

A.
B.
C.
D.
E.

53. Schraeder Corporation has 20,000 shares

outstanding at $30 each. The firm expects
to raise $200,000 via a rights offering at a
subscription price of $25. How many rights
are required for each new share?

A.
B.
C.
D.
E.

54. Assume a stock has an ex-rights price of

$32. The rights offer has a requirement of 3
rights per new share and a subscription
price of $30. What is the rights-on stock
price?

A.
B.

C.

D.
E.
55. A rights offer was set at four rights plus $25
for each new share. What is the rights-on
price if the ex-rights price is $30?

A.
B.
C.
D.
E.

56. A stock has a rights-on price of $20, an ex-

rights price of $18.25, and the number of
rights needed to buy one new share is 5.
Assuming everything else is held constant,
what is the subscription price?

A.

B.

C.

D.

E.
57.
Assume there are three upcoming IPOs (A,
B, and C) that are priced at $20 a share. You
place an order with your broker to purchase
500 shares of each of the three offerings.
Further assume that A is oversubscribed and
your allocation is only 100 shares. You
receive a full allocation on both B and C.
Offer A is undervalued by $13, B is
overvalued by $8, and C is overvalued by
$1. What will be your combined total profit
or loss on these three investments?

A.

B.

C.

D.

E.
58.
The Market Place recently offered 5,000
shares of stock for sale via a Dutch auction.
The firm received bids as follows: 500
shares at $22.50; 2,500 shares at $22.20;
3,300 shares at $22; and 5,500 shares at
$21. Ignoring all costs, how much will the
firm receive from this auction?

A.

B.

C.

D.

E.
59. Lee started a firm which he recently took
public with a new stock issue of 1 million
shares. As the firm’s founder he personally
owns 1.2 million shares, all of which he
owned prior to the new stock issue. The
offer price of the IPO was $16 a share. The
price paid to the firm was $14.20 a share
and the closing price on the IPO date was
$19 a share. How much of a loss did Lee
personally experience due to the IPO’s
underpricing?

A.

B.

C.

D.

E.
60.
Nelson’s Metallurgy needs $1.36 million to
fund an expansion project. The firm has
decided to raise the funds through a
negotiated offering. The terms of the offer
include an offer price of $22.50 a share and
an underwriting spread of 8.1 percent. How
many shares must the firm sell in order to
raise the funds it needs?

A.

B.

C.

D.

E.
61. A firm has negotiated a seasoned equity
offer that will provide the firm with $1.68
million in net proceeds. The underwriting
spread is 7.35 percent and the firm needs to
sell 50,000 shares. What is the offer price?

A.

B.

C.

D.

E.
62.
Four Wheels requires $1.75 million to fund a
new project and has decided to raise the
funds via a seasoned stock offering. Assume
the firm will incur $140,000 in indirect costs
and pay 8.63 percent of the gross proceeds
in direct costs. How much does the firm
need to raise in total to cover all of the costs
as well as fund the new project?

A.

B.

C.

D.

E.
63.
Lasko’s has 250,000 shares of stock
outstanding, $400,000 in perpetual annual
earnings, and a discount rate of 16 percent.
The firm is considering a new project that
has initial costs of $350,000 and annual
perpetual cash flows of $60,000. What will
be the change in the firm’s stock price per
share if this project is accepted?

A.

B.

C.

D.

E.
64.
The Direct Interactive Publishing Company is
planning to raise $200 million dollars in new
capital. There are currently 50 million shares
outstanding with an estimated market price
of $60 each. The corporate officers are
debating whether to use a rights offering
(with or without a standby underwriting) or
have the issue fully underwritten. The
company is currently listed on a regional
exchange and plans to list on a national
exchange after the security issue. List and
explain three advantages/disadvantages of
each issue method.

65. Discuss what a Dutch auction is and how it

works.
66. Discuss the stages of venture capital
financing, defining each in detail.

67. What are venture capitalists and what is

their role in raising capital for firms?

68. Identify six components that comprise the

total costs associated with issuing
securities.
69. Identify and explain the key differences
between public issues of debt and direct
private long-term debt financing.
 Chapter 20 Key
1.
The first equity issue offered to the general
public by a firm is a:

A.
B.
C.
D.
E.
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Difficulty: 1 Basic
Ross - Chapter 20 #1
Section: 20.3
Topic: Types of offerings

2. An equity issue sold to the firm's existing

stockholders is called a:

A.
B.
C.
D.
E.
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Difficulty: 1 Basic
Ross - Chapter 20 #2
Section: 20.3
Topic: Types of offerings

3. Management's first step in any issue of

securities to the public is to:

A.
B.
C.
D.
E.
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 Blooms: Remember
Difficulty: 1 Basic
Ross - Chapter 20 #3
Section: 20.2
Topic: Basics of issuing securities

4. The first public equity issue offered by a

company is commonly referred to as a(n):

A.
B.
C.
D.
E.
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Difficulty: 1 Basic
Ross - Chapter 20 #4
Section: 20.3
Topic: Types of offerings

5. An equity issue up to $1 million offered in

small increments to a large number of
people via the Internet is most commonly
referred to as:

A.
B.
C.
D.
E.
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Difficulty: 1 Basic
Ross - Chapter 20 #5
Section: 20.3
Topic: Types of offerings

6. The green shoe provision is used to:

A.
B.
C.
D.
E.
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Difficulty: 2 Intermediate
Ross - Chapter 20 #6
Section: 20.4
Topic: Basics of issuing securities
7. Dilution commonly refers to the:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #7
Section: 20.9
Topic: Dilution

8. A preliminary prospectus contains:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #8
Section: 20.2
Topic: Basics of issuing securities

9. A company must file a registration

statement with the SEC providing various
financial and company information in order
to sell new securities to the public. This
registration statement does not need to be
filed if the:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #9
Section: 20.2
Topic: Basics of issuing securities
10. Security issues that are governed by
Regulation A are:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #10
Section: 20.2
Topic: Basics of issuing securities

11.
Potential investors primarily obtain detailed
information regarding a new issue by
reading the:

A.

B.

C.
D.
E.
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Ross - Chapter 20 #11
Section: 20.2
Topic: Basics of issuing securities

12. A registration statement is effective on the

20th day after filing unless:

A.
B.
C.
D.
E.
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Difficulty: 2 Intermediate
Ross - Chapter 20 #12
Section: 20.2
Topic: Basics of issuing securities

13. A firm commitment arrangement with an

investment banker occurs when the:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #13
Section: 20.4
Topic: Underwriting

14. Which one of the following services is least

apt to be offered to a corporation by an
investment bank?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #14
Section: 20.4
Topic: Underwriting

15. In a best efforts offering the investment

bank makes its money primarily by earning:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #15
Section: 20.4
Topic: Underwriting
16. Under the _______ method, the underwriter
buys the securities for less than the offering
price and accepts the risk of not selling the
issue, while under the _______ method, the
underwriter does not purchase the shares
but merely acts as an agent.

A.
B.
C.
D.
E.
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Ross - Chapter 20 #16
Section: 20.4
Topic: Underwriting

17. Empirical evidence suggests that new equity

issues are generally:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #17
Section: 20.4
Topic: Costs of issuing securities

18. Negotiated offers generally:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #18
Section: 20.4
Topic: Basics of issuing securities
19. Venture capitalists are:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #19
Section: 20.1
Topic: Venture capital

20. Empirical evidence suggests that upon

announcement of a seasoned equity issue,
current stock prices generally:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #20
Section: 20.5

21. Debt capacity is often offered as a reason

for a stock price to decline when additional
equity securities are issued. The primary
reason that supports this argument is that:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #21
Section: 20.5
Topic: Raising capital
22. Direct expenses of an IPO include the:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #22
Section: 20.6
Topic: Costs of issuing securities

23. In comparison to debt issuance expenses,

the total direct costs of equity issues are:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #23
Section: 20.6
Topic: Costs of issuing securities

24. To determine the value of a rights offering,

the stockholder needs to know the following
two pieces of information in addition to the
current stock price, the:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #24
Section: 20.7
Topic: Rights offerings
25. Assuming everything else is constant, when
a stock goes ex-rights the stock price
should:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #25
Section: 20.7
Topic: Rights offerings

26. If current shareholders want to acquire one

share of stock under a rights plan they
must:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #26
Section: 20.7
Topic: Rights offerings

27. Which one of the following statements is

true concerning a rights offering?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #27
Section: 20.7
Topic: Rights offerings
28. Shareholders who have rights are always:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #28
Section: 20.7
Topic: Rights offerings

29. A standby underwriting arrangement in

conjunction with a rights offering provides
the:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #29
Section: 20.7
Topic: Rights offerings

30. In a typical deal, the venture capitalist will

receive at least ______ percent of the equity
of financed firm.

A.
B.
C.
D.
E.
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Ross - Chapter 20 #30
Section: 20.1
Topic: Venture capital
31. Corporations primarily use the shelf
registration method of security sales
because:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #31
Section: 20.10
Topic: Basics of issuing securities

32. Venture capitalists will frequently:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #32
Section: 20.1
Topic: Venture capital

33. Arguments offered as explanations, with or

without market evidence, as to why most
U.S. equity issues are sold without rights
include all of the following except:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #33
Section: 20.8
Topic: Rights offerings
34. All of the following are major requirements
needed to qualify for shelf registration
except:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #34
Section: 20.10
Topic: Basics of issuing securities

35. One argument against the use of shelf-

registration is:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #35
Section: 20.10
Topic: Basics of issuing securities

36. The market for venture capital refers to the:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #36
Section: 20.1
Topic: Venture capital
37. Venture capitalists provide financing for new
firms from the seed and start-up stage all
the way to mezzanine and bridge financing.
In exchange for this financing, venture
capitalists generally receive:

A.
B.
C.
D.
E.
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Ross - Chapter 20 #37
Section: 20.1
Topic: Venture capital

38. Which one of the following is not one of the

four main functions provided by
underwriters?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #38
Section: 20.4
Topic: Underwriting

39. Which type(s) of dilution are relevant to a

firm’s shareholders when the firm’s shares
are issued with rights?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #39
Section: 20.9
Topic: Dilution
40.
Dream Makers has expended almost all of
its start-up funds and is seeking venture
capital to begin manufacturing. Which type
of financing is it seeking?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #40
Section: 20.1
Topic: Venture capital
41.
The price at which offered securities are
sold in a Dutch auction underwriting is
determined by the:

A.

B.

C.

D.

E.

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Ross - Chapter 20 #41
Section: 20.4
Topic: Types of offerings
42.
Green Shoe options generally last ____ days
and benefit ____.

A.

B.

C.

D.

E.

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Ross - Chapter 20 #42
Section: 20.4
Topic: Basics of issuing securities
43.
Which one of these applies to the after
market period?

A.

B.

C.

D.

E.

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Difficulty: 2 Intermediate
Ross - Chapter 20 #43
Section: 20.4
Topic: Basics of issuing securities
44.
Oversubscription is most commonly the
result of:

A.

B.

C.

D.

E.

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Ross - Chapter 20 #44
Section: 20.4
Topic: Basics of issuing securities
45.
Which type of offering will generally incur
the lowest direct issue costs as a
percentage of gross proceeds?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #45
Section: 20.6
Topic: Costs of issuing securities
46.
Which one of these characteristics is least
applicable to term loans?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #46
Section: 20.6
Topic: Costs of issuing securities
47.
Which one of these statements related to
debt financing is correct?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #47
Section: 20.11
Topic: Debt issues

48. The Wordsmith Corporation has 40,000

shares outstanding with a market price of
$25 each. The firms expects to raise
$200,000 via a rights offering at a
subscription price of $20. How many rights
must be submitted to acquire one new
share?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #48
Section: 20.7
Topic: Rights offerings
49. Assume it requires 3 rights to obtain a new
share in a rights offering. If the stock's price
prior to the ex-rights date is $25 and the ex-
rights price is $22.75, what is the value of
each right?

A.
B.
C.
D.

E.

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Ross - Chapter 20 #49
Section: 20.7
Topic: Rights offerings

50. You own 200 shares of a stock valued at $21

a share. Each share is entitled to one right.
A rights offer grants you the option of
obtaining one new share for two rights plus
$17. What is the value of each right?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #50
Section: 20.7
Topic: Rights offerings
51. Regional Power wants to raise $2.4 million in
new equity via a rights offering with a
subscription price of $12. There are
currently 2.6 million shares outstanding,
each with one right. How many rights are
needed to purchase one new share?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #51
Section: 20.7
Topic: Rights

52. Western Markets has 150,000 shares

outstanding with a market price per share of
$15. Each share is entitled to one right. If
the firm sets a rights offer as 5 rights plus
$10 for each new share, what will be the ex-
rights price per share?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #52
Section: 20.7
Topic: Rights offerings
53. Schraeder Corporation has 20,000 shares
outstanding at $30 each. The firm expects
to raise $200,000 via a rights offering at a
subscription price of $25. How many rights
are required for each new share?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #53
Section: 20.7
Topic: Rights offerings

54. Assume a stock has an ex-rights price of

$32. The rights offer has a requirement of 3
rights per new share and a subscription
price of $30. What is the rights-on stock
price?

A.
B.

C.

D.
E.
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Ross - Chapter 20 #54
Section: 20.7
Topic: Rights offerings
55. A rights offer was set at four rights plus $25
for each new share. What is the rights-on
price if the ex-rights price is $30?

A.
B.
C.
D.
E.
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Ross - Chapter 20 #55
Section: 20.7
Topic: Rights offerings

56. A stock has a rights-on price of $20, an ex-

rights price of $18.25, and the number of
rights needed to buy one new share is 5.
Assuming everything else is held constant,
what is the subscription price?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #56
Section: 20.7
Topic: Rights offerings
57.
Assume there are three upcoming IPOs (A,
B, and C) that are priced at $20 a share. You
place an order with your broker to purchase
500 shares of each of the three offerings.
Further assume that A is oversubscribed and
your allocation is only 100 shares. You
receive a full allocation on both B and C.
Offer A is undervalued by $13, B is
overvalued by $8, and C is overvalued by
$1. What will be your combined total profit
or loss on these three investments?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #57
Section: 20.4
Topic: Public offerings
58.
The Market Place recently offered 5,000
shares of stock for sale via a Dutch auction.
The firm received bids as follows: 500
shares at $22.50; 2,500 shares at $22.20;
3,300 shares at $22; and 5,500 shares at
$21. Ignoring all costs, how much will the
firm receive from this auction?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #58
Section: 20.4
Topic: Types of offerings
59. Lee started a firm which he recently took
public with a new stock issue of 1 million
shares. As the firm’s founder he personally
owns 1.2 million shares, all of which he
owned prior to the new stock issue. The
offer price of the IPO was $16 a share. The
price paid to the firm was $14.20 a share
and the closing price on the IPO date was
$19 a share. How much of a loss did Lee
personally experience due to the IPO’s
underpricing?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #59
Section: 20.6
Topic: Costs of issuing securities
60.
Nelson’s Metallurgy needs $1.36 million to
fund an expansion project. The firm has
decided to raise the funds through a
negotiated offering. The terms of the offer
include an offer price of $22.50 a share and
an underwriting spread of 8.1 percent. How
many shares must the firm sell in order to
raise the funds it needs?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #60
Section: 20.6
Topic: Costs of issuing securities
61. A firm has negotiated a seasoned equity
offer that will provide the firm with $1.68
million in net proceeds. The underwriting
spread is 7.35 percent and the firm needs to
sell 50,000 shares. What is the offer price?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #61
Section: 20.6
Topic: Costs of issuing securities
62.
Four Wheels requires $1.75 million to fund a
new project and has decided to raise the
funds via a seasoned stock offering. Assume
the firm will incur $140,000 in indirect costs
and pay 8.63 percent of the gross proceeds
in direct costs. How much does the firm
need to raise in total to cover all of the costs
as well as fund the new project?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #62
Section: 20.6
Topic: Costs of issuing securities
63.
Lasko’s has 250,000 shares of stock
outstanding, $400,000 in perpetual annual
earnings, and a discount rate of 16 percent.
The firm is considering a new project that
has initial costs of $350,000 and annual
perpetual cash flows of $60,000. What will
be the change in the firm’s stock price per
share if this project is accepted?

A.

B.

C.

D.

E.

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Ross - Chapter 20 #63
Section: 20.9
Topic: Dilution
64.
The Direct Interactive Publishing Company is
planning to raise $200 million dollars in new
capital. There are currently 50 million shares
outstanding with an estimated market price
of $60 each. The corporate officers are
debating whether to use a rights offering
(with or without a standby underwriting) or
have the issue fully underwritten. The
company is currently listed on a regional
exchange and plans to list on a national
exchange after the security issue. List and
explain three advantages/disadvantages of
each issue method.

Rights method: Advantages: lowest cost

method, maintains ownership percentage,
shareholders can fully participate and
maintain wealth.

Disadvantages: shareholders may not have

capital, offer may not be fully subscribed,
use of standby underwriting involves
additional costs.

Underwriting method:

Advantages: advice on issue characteristics

and pricing from investment bankers,
access to broader market, investors view
underwriters as certifying the issue value,
net proceeds known in advance if a firm
commitment.

Disadvantages: costly, may be undersold if

a best efforts underwriting, current
shareholders may not be able to maintain
 ownership percentage.

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Difficulty: 3 Challenge
Ross - Chapter 20 #64
Section: 20.3
Topic: Basics of issuing securities

65. Discuss what a Dutch auction is and how it

works.

In a Dutch auction, the underwriter does not

set a fixed price, but rather conducts an
auction in which investors bid for the
shares. This process is also known as a
uniform price auction. Bidders submit bids
stating the number of shares desired and
the price they are willing to pay. The firm
then sets the price at the highest level that
will result in a sale of all offered shares. All
bidders receive the same price. If there are
more shares offered at the final price and
above than the firm desires, then bids will
be fulfilled on an allocated basis with each
successful bidder receiving a portion of the
shares stated in their bid.

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Ross - Chapter 20 #65
Section: 20.4
Topic: Basics of issuing securities
66. Discuss the stages of venture capital
financing, defining each in detail.

Well-known classifications of the stages of

venture capital financing are:

1. Seed money stage: A small amount of

financing is needed to prove a concept or
develop a product. Marketing is not included
in this stage.

2. Start-up: Financing for firms that started

within the past year. Funds are likely used to
pay for marketing and product development
expenditures.

3. First-round financing: Additional money to

begin sales and manufacturing after a firm
has spent its start-up funds.

4. Second-round financing: Financing is

earmarked for working capital. for a firm
that is currently selling its product but still
losing money.

5. Third-round financing: Financing for a

company that is at least breaking even and
is contemplating an expansion. This is also
known as mezzanine financing.

6. Fourth-round financing: Money provided

for firms that are likely to go public within
half a year. This round is also known as
bridge financing.

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Difficulty: 3 Challenge
 Ross - Chapter 20 #66
Section: 20.1
Topic: Venture capital

67. What are venture capitalists and what is

their role in raising capital for firms?

Venture capitalists are financial

intermediaries that raise funds from outside
investors. Venture capitalist firms, otherwise
known as VC firms, are typically organized
as limited partnerships which partner with
institutional investors such as pension plans,
endowments, and corporations. This is the
key characteristic that separates venture
capitalists from angel investors who
typically invest their own money. Second,
venture capitalists play an active role in
overseeing, advising, and monitoring the
companies in which they invest. Third,
venture capitalists generally do not want to
hold the investment for a long time period.
In contrast, they generally develop their exit
strategy prior to the initial investment so
they are more easily able to move forward
and exit the investment.

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Blooms: Analyze
Difficulty: 3 Challenge
Ross - Chapter 20 #67
Section: 20.1
Topic: Venture capital
68. Identify six components that comprise the
total costs associated with issuing
securities.

The six components are:

Gross spread: difference between offer price

and price the issuer receives

Other direct expense: costs incurred by the

issuer such as legal and accounting fees

Indirect expenses: costs such as

management time spent on the issue

Abnormal returns: the stock price decline

associated with the announcement of a
seasoned offering

Underpricing: difference between the actual

after-issue market price and the offer price

Green Shoe option: additional shares

provided at the offer price to the
underwriters to cover overallotments; cost
per share equals the after-issue market
price minus the offer price

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Difficulty: 3 Challenge
Ross - Chapter 20 #68
Section: 20.6
Topic: Costs of issuing securities
69. Identify and explain the key differences
between public issues of debt and direct
private long-term debt financing.

The key differences are:

1. direct long-term loans avoid SEC

registration,

2. direct placements generally have more

restrictive covenants,

3. private placements are easier to

renegotiate

4. private placements are generally funded

by institutions such as life insurance
companies, pension funds, and commercial
banks while public issues are open to all
investors

5. private placements are less expensive

than public offerings

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Difficulty: 3 Challenge
Ross - Chapter 20 #69
Section: 20.11
Topic: Debt issues
Chapter 20 Summary