k. Describe the typical first-day return of an IPO and the long-term returns to IPO investors.
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Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point that expansion throughout the entire Southeast is feasible. The proposed expansion would require the firm to raise about $18.3 million in new capital. Because Randy’s currently has a debt ratio of 50% and because family members already have all their personal wealth invested in the company, the family would like to sell common stock to the public to raise the $18.3 million. However, the family wants to retain voting control. You have been asked to brief family members on the issues involved by answering the following questions: |
Verified Answer
The first day average return of an initial public offer (IPO) is generally higher because the underwriter or the company tends to follow the practice of underpricing, that is, offering the securities to the public at lower than the actual price to attract the investors and create a boosting demand in the market. So, in view of lower prices, investors subscribe to the securities.
Over the time, returns generated from the IPO are lower than the average returns that implies the offering price of securities is too low but the first day run up is too high. The adjustments in the price at the time of public offer reduces the returns of an investor in the long run.
