Ask Me Help Desk - Initial Return Earned by Investors

Quote:

Originally Posted by xodiana

West Coast Manufacturing Company (WCMC) is executing an initial public offering with the
following characteristics. The company will sell 10 million shares at an offer price of $25 per
share, the underwriter will charge a 7 percent underwriting fee, and the shares are expected to sell
for $32 per share by the end of the first day’s trading. Assuming this IPO is executed as expected,
answer the following:
a. Calculate the initial return earned by investors allocated shares in the IPO

The book's answer was a 28% gain in one day which the only way I could get that answer was to divide 7%/$25

Or do you calculate the answer by:

100% - (25/32) which would give you 21.88% gain in one day

xodiana - you can simply take the sell price of the stock for the investors and divide it by the purchase price of $25 and subtract that by 1:

(32/25)-1: .28

I think you are trying to figure out what to do with the 7% underwriting fee and are getting confused with that. It's been a while but doesn't the book tell you that the underwriting fee is assessed after the funds have been taken in at the initial IPO? In other words, 10 million shares x $25 is $250,000,000 raised in capital; the underwriting fee then would amount to $17,500,000. This fee would have no impact on what the return to the investors was, though.

Let me know what the books says on that.