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

We start by identifying what underpricing means in an IPO: the difference between the market price after the IPO and the offering price times the number of shares issued represents value transferred from the issuing firm’s existing shareholders to the new investors who buy at the IPO price.

First, note the key figures:
- Shares issued in the IPO: 2 million
- IPO price: $15 per share
- Post-IPO market price: $20 per share

Compute the gain enjoyed by the new investors due to underpricing:
- If the stock trades at $20 after the IPO, while it was issued at $15, the underpricing gain per share is $20 − $15 = $5.
- Total underpricing gain for the 2 million newly issued shares is 2,000,000 × $5 = $10,000,000.

Thus, the value transferred from Mars’ shareholders to the new investors due to underpricing is $10 million.

Now consider the underwriting fee: Mars pays an underwriting fee of 5% of gross proceeds. Gross proceeds from the issue are 2 million × $15 = $30 million, so the underwriting fee is 0.05 × $30 million = $1.5 million. This fee reduces the net funds raised by the company but does not directly change the magnitude of underpricing loss to existing shareholders in the standard (first-order) valuation framework. The underpricing loss remains the $10 million representing the difference between the post-IPO price and the offering price times the number of newly issued shares.

Summary: The value lost by Mars’ existing shareholders due to underpricing is $10 million, which comes from the $5 per share difference over 2 million shares.

SP25-BL-BUS-F402-4299 Raising Capital and IPOs

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