In its negotiations with its investment bankers, Patton Electronics has reached an agreement whereby the investment bankers receive a smaller fee now (6% of gross proceeds versus their normal 10%) but also receive a 1-year option to purchase an additional 200,000 shares at $5.00 per share. Patton will go public by selling $5,000,000 of new common stock. 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. $1,235,925b. $1,300,973c. $1,369,446d. $1,441,522e. $1,517,391

Question

Business

Hope Morrison

13 March, 21:38

In its negotiations with its investment bankers, Patton Electronics has reached an agreement whereby the investment bankers receive a smaller fee now (6% of gross proceeds versus their normal 10%) but also receive a 1-year option to purchase an additional 200,000 shares at $5.00 per share. Patton will go public by selling $5,000,000 of new common stock. 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. $1,235,925b. $1,300,973c. $1,369,446d. $1,441,522e. $1,517,391

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Angelina Mooney · Answer 1

Present Value of Entire Underwriting Compensation=

Commission as a fixed % of Gross Proceeds + PV of Gain by exercising option to purchase shares.

Fixed Commission = 5000000*0.06

=300000

Gain by exercising option=200000 * (12-5)

=1400000

PV of Gain = 1400000 / (1+0.15)

=1400000/1.15

=1217391.30

PV of Total Compensation=300000+1217391.30

=1517391.30