The owner of Wolverine Airlines wishes to take her firm public by selling 3 mill

Question

The owner of Wolverine Airlines wishes to take her firm public by selling 3 million shares. The underwriter determines that the true value will be $15 with probability .4 and $8 with probability .6.

There are a group of uninformed investors who are willing to buy 6 million shares as long their expected profits from purchasing are at least 0 (i.e., expected profits must be non-negative). This group also assesses that the probability of the true value of the shares being $15 is .4 and the probability of having a true value of $8 is .6. There is a group of informed investors who always know whether the true value is $15 or $8. They are willing to order 2 million shares if the offer price is less than the true value.

(a) Calculate the highest offer price at which the entire issue will always sell.

(b) Could an uniformed investor make money on average by submitting an order to buy some shares of the new issue? Why or why not?

(c) If the stock is sold at the offer price you calculated in (a), what will be the expected percentage change in the stock price on its first day of trading?

Explanation / Answer

Ans-

The underwriter determines that the true value will be $15 with probability 0.4 and $8 with probability 0.6

a)highest offer price at which the entire issue will always sell=(15*0.4+8*0.6)

=$10.6

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