Raising Capital

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Raising Capital
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New Ventures

• Venture Capital (Private Equity)
• Bank capital hard to get for start ups
• Too early to issue equity to general public and
  start trading on stock exchange
• VC brings and expertise
• Management skills
• Sourcing new funds
• Knowing when to stop
• Multiple rounds (stages of financing)
• Control rights

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Issuing Equity

• Selling common stock to the public
• Can be initial public offering (IPO) or Seasoned
  Equity Offering (SEO)
• Cash offer sell to general investing public
• Rights Offer give right to buy new equity to
  existing shareholders (they can then sell right
  to other investors)
• If company chooses cash offer then several other
  decisions must be made
• Usually hire an investment bank to help

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Investment Banking

• What does an investment bank actually do?
• Origination/Pricing
• What type of security to issue
• Risk bearing/Sales effort
• Proceeds risk (Firm commitment/bought deal vs.
  best efforts)
• Road show selling issue to institutional
  investors
• Paper work (Filing forms with security
  commissions)

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(No Transcript)
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IPO TIMELINE

• Issue Decision
• Call underwriter
• Negotiate with underwriter
• Other experts arrive
• From Red Herring to final prospectus
• Registration is effective
• Offer date

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The 7 Solution

• went public in 1998.
• No. of shares sold in IPO 3,500,000
• Per share figures
• Offer price 18.00
• Underwriting discount (commission) 1.26
• eBay and selling shareholders receive 16.74
  
• Total figures (entire offering)
• Investors pay (18 3.5m) 63,000,000
• Underwriter gets (1.26 3.5m) 4,410,000
• eBay, selling shareholders get 58,590,000
• Percentage fee (spread) 4.21m / 63m 0.07
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• Nice work, if you can get it

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IPOs Continued

• Green Shoe Option (overallotment option)
• Underwriter has right to increase number of
  shares sold by up to 10
• Extra shares sold only if demand is strong
• Underwriter gets shares below offer price
• Will earn the 7 spread on these additional
  shares as well
• Just another option

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Capital Structure Cost of Capital

• Suppose that we are in a world with no taxes or
  transaction costs. A firm with 500,000 shares
  outstanding is financed with 50 debt and 50
  equity, and based on their risk its assets of
  10 million are expected to earn a 10 return.
  Suppose required return on equity is 15 and the
  cost of debt is 5, so equity holders expect to
  receive 15 5m 750,000 a year while bond
  holders expect to get 5 5m 250,000. Note
  that each shareholder holds a share worth 10 and
  expects to receive 1.5 a share per year. (All
  cash flows are assumed to be perpetual.) Now if
  you decrease debt financing to 25 and increase
  equity to 75 by issuing an additional 250,000
  shares for 10 each and using the proceeds to
  retire half of your debt, what will happen to i)
  the expected return on assets and ii) the
  expected return on equity? For simplicity, assume
  that debt is risk free.

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Put Your Stock in Gold?

• Your neighbour just found out that youre taking
  a Finance class at University and comes over to
  ask your advice. He tells you his investment
  advisor says only to expect 8 return on his gold
  investments. He thinks this is crazy since gold
  has a standard deviation twice as high as the TSE
  300 and hes earned 15 investing in the TSE 300
  through an index fund. Why would the expected
  return be so low on riskier gold? What do you say
  in response?

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Choix Multiple

• If the semi-strong form of the efficient market
  hypothesis holds, then
• future stock prices can be predicted based on
  past prices.
• investors should not invest in index funds.
• stock prices reflect all publicly available
  information.
• stock prices reflect all relevant information
  whether public or private.
• investors could do well by carefully studying
  firms financial statements.

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De Múltiple Opción

• Which of the following is true about a security
  that plots below the security market line?
• The securitys return is lower than what it
  should be based on its risk.
• The security is under-valued.
• The securitys return is higher than what it
  should be based on its risk.
• A) and B) only.
• B) and C) only.

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Multiple Choice

• The benefits from diversification are the
  greatest when the returns on two assets
• are independent.
• are perfectly positively correlated.
• have a negative correlation coefficient.
• have a small positive correlation coefficient.
• have a correlation coefficient of zero.

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Option Prices

• You look in the newspaper and see the following
  prices for Mrozek Inc. common stock and American
  options on Mrozek equity
• Stock price 60
• Price of put option (70 strike price) 8
• Given these prices, what should you do?
• Is there something wrong here? Explain!

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Option Prices

• You also see the following entries for American
  call options on Mrozek Inc. stock (see Table).
• Is there something wrong here? Explain! (Comment
  on whether you would be likely to see something
  like this in practice!)

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XYZ Inc. Option Valuation

• Currently a share of stock in XYZ Inc. sells for
  50. Next year it will be worth either 40 or
  60. If the risk free rate is 8, what is the
  price of a call option with a strike price of
  55? What if the possible prices next year are
  30 and 70? What general property of option
  prices does this demonstrate?

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Capital Structure

• The market value of a firm with 2,000,000 in
  debt is 6,800,000. The pre-tax cost of debt for
  this firm equals 9 (EAR). If the firm were 100
  equity financed, the cost of (unlevered) equity
  would be 14 (EAR). (Assume that both the firms
  cash flows and the debt are perpetual.) Corporate
  taxes are 40 and interest expenses are tax
  deductible, while dividends are not. Assume that
  the agency and bankruptcy costs of debt are zero.
• What would be the value of the firm if it were
  financed entirely with equity?
• Calculate the WACC for the levered firm!
• How would your answer to a) change if interest
  expenses were NOT tax deductible?

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Black-Scholes Option Pricing

• Value of call option on a asset
• Current stock price 44
• Strike/Exercise price 42
• Time to expiration 9 months
• Stock price volatility (?, per year) 30
• Continuously compounded risk-free rate 8