What is the total cost to the firms original investors
Course:- Corporate Finance
Reference No.:- EM13842749

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Problem on Implied Price of Funding

Starware Software was founded last year to develop software for gaming applications. Initially, the founder invested $800,000 and received 8 million shares of stock. Starware now needs to raise a second round of capital, and it has identified an interested venture capitalist. This venture capitalist will invest $1 million and wants to own 20% of the company after the investment is completed.

a) How many shares must the venture capitalist receive to end up with 20% of the company? What is the implied price per share of this funding round?

b) What will the value of the whole firm be after this investment (the post-money valuation)?

Problem on IPO

Your firm has 10 million shares outstanding, and you are about to issue 5 million new shares in an IPO. The IPO price has been set at $20 per share, and the underwriting spread is 7%. The IPO is a big success with investors, and the share price rises to $50 on the first day of trading.

a) How much did your firm raise from the IPO?

b) What is the market value of the firm after the IPO?

c) Assume that the post-IPO value of your firm is its fair market value. Suppose your firm could have issued shares directly to investors at their fair market values in a perfect market with no underwriting spread and no underpricing. What would the share price have been in this case, if you raise the same amount as in part a)?

d) Comparing part b) and part c), what is the total cost to the firm's original investors due to market imperfections from the IPO?

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