The Woods Co. and the Garcia Co. have both announced IPOs at $56 per share. One

Question

The Woods Co. and the Garcia Co. have both announced IPOs at $56 per share. One of these is undervalued by $8. and the other is overvalued by $2. but you have no way of knowing which is which. You plan on buying 1.200 shares of each issue. If an issue is underpriced. it will be rationed. and only half your order will be filled. If you could get 1.200 shares in Woods and 1.200 shares in Garcia. what would your profit be? (Do not round intermediate calculations.) Profit $ What profit do you actually expect? (Do not round intermediate calculations.) Expected profit $

Explanation / Answer

a) If you receive 1200 shares of each, the profit is:

Profit = 1200($8) – 1200($2) = $7200

Since you will only receive one-half of the shares of the oversubscribed issue, your profit will be:

Expected profit = 600($8) – 1200($2) = 2400

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