Question

value: 13.00 points P15-4 IPO Underpricing [LO3] The Woods Co. and the Mickelson Co. have both announced IPOs at $49 per share. One of these is undervalued by $14, and the other is overvalued by $6, but you have no way of knowing which is which. You plan to buy 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled. Assume you could get 1,000 shares in Woods and 1,000 shares in Mickelson. (a) What would your profit be? (Do not round your intermediate calculations.) (Click to select) (b) What profit do you actually expect? (Do not round your intermediate calculations.) (Click to select) References eBook& Resources Dimiculty: Basic Section: 15.05 IPOs and P15-4 IPO Underpricing [LO3] Learning Objective: 15-03 Initial public 0888 esc 4

Answer 1

a). If you receive 1,000 shares of each, the profit is:

Profit = 1,000($14) – 1,000($6)

Profit = $14,000 - $6,000 = $8,000

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

Expected profit = 500($14) – 1,000($6)

Expected profit = $7,000 - $6,000 = $1,000

This is an example of the winner’s curse.