Tuttle Buildings Inc. has decided to go public by selling $6,000,000 of new comm

Question

Tuttle Buildings Inc. has decided to go public by selling $6,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (6% of gross proceeds versus their normal 10%) in exchange for a 1 year option to purchase an additional 200,000 shares at $5.00 per share. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12.00 per share one year from now. If the $12 price occurs, what would the present value of the entire underwriting compensation be? Assume that the investment banker's required return on such arrangements is 15%, and ignore taxes.

a. $1,507,391

b. $1,577,391

c. $1,569,391

d. $1,541,391

e. $1,517,391

Explanation / Answer

If the price actually reaches $12 and the Investment bank has a right to buy 200000 shares at the rate of $5 , the net gain will be=200000*(12-5) 1400000 The PV of the above Gain with discount rate 15% = 1400000/1.15 (A) 1217391 Fee taken by the banker on $6000000 at the rate of 6%=0.06*6000000 (B) 360000 Total present value of the entire underwriting compensation=A+B 1577391 So the answer is (b)

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