Suppose that Mars, a large private company, is planning to do an IPO. The company currently has 10 million shares outstanding, and with the help of its lead underwriter, Morgan Stanley, Mars has decided to issue 2 million shares priced at $15 each. In addition, the company has agreed to an underwriting fee of 5%.

If the company’s stock price rises to $20 after the IPO, how much value is lost by Mars’ shareholders because of underpricing (in million)?

Question

Suppose that Mars, a large private company, is planning to do an IPO. The company currently has 10 million shares outstanding, and with the help of its lead underwriter, Morgan Stanley, Mars has decided to issue 2 million shares priced at $15 each. In addition, the company has agreed to an underwriting fee of 5%.

If the company’s stock price rises to $20 after the IPO, how much value is lost by Mars’ shareholders because of underpricing (in million)?

BlackTom AI · Accepted Answer

Let’s break down the situation and compare what Mars could have received vs what it actually got after the IPO underpricing.

First, identify the key numbers: Mars issues 2 million new shares at an offer price of $15 each, with an underwriting fee of 5%. If the stock price rises to $20 after the IPO, the new investors who bought at $15 would have received $20 value per share in the market, creating a $5 per-share difference.

Option 1: $5 per share difference, totaling $5 × 2,000,000 = $10,000,000. This would represent the gain per new investor from the higher market price, not the value lost by Mars’ existing shareholders. It misattributes the source of the transfer of value.

Option 2: $10,000,000. This matches the total transfer of wealth created by the underpricing: new investors pay $15 but can sell at $20, so the underwriter and existing shareholders effectively lose value equal to the difference times the number of new shares issued. The downstream effect is that Mars’ existing shareholders see a $10 million reduction in value relative to a scenario with no underpricing.

Option 3: $15 per share difference, totaling $30,000,000. This overstates the gain per share from the post-IPO price; the actual per-share differential is $5 (20 − 15), not $15. There is no basis for a $15 gap in this setup.

Option 4: None of the above. Since the correct calculation is a $10,000,000 transfer to new investors (and an equivalent implied loss to existing Mars shareholders), this option would be incorrect.

Additional nuance: The 5% underwriting fee affects Mars’s net proceeds from the sale (2,000,000 × $15 × (1 − 0.05) = $28.5 million), but the question asks for value lost by Mars’ shareholders due to underpricing relative to the post-IPO market price, which is driven by the $5 per share uplift for 2 million shares, i.e., $10 million. The underwriting fee affects proceeds received but does not change the per-share underpricing difference that translates into value transfer between investors and the company’s pre-IPO holders.

SP25-BL-BUS-F402-5344 Raising Capital and IPOs

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