Question 14.3: Fleming Educational Software, Inc., is selling 500,000 share...
Fleming Educational Software, Inc., is selling 500,000 shares of stock in an auction IPO. At the end of the bidding period, Fleming’s investment bank has received the following bids:
What will the offer price of the shares be?
| Price ($) | Number of Shares Bid |
| 8.00 | 25,000 |
| 7.75 | 100,000 |
| 7.50 | 75,000 |
| 7.25 | 150,000 |
| 7.00 | 150,000 |
| 6.75 | 275,000 |
| 6.50 | 125,000 |
PLAN
First, we must compute the total number of shares demanded at or above any given price. Then, we pick the highest price that will allow us to sell the full issue (500,000 shares).
EXECUTE
Converting the table of bids into a table of cumulative demand, we have:
For example, the company has received bids for a total of 125,000 shares at $7.75 per share or higher (25,000 + 100,000 = 125,000).
Fleming is offering a total of 500,000 shares. The winning auction price would be $7 per share, because investors have placed orders for a total of 500,000 shares at a price of $7 or higher. All investors who placed bids of at least this price will be able to buy the stock for $7 per share, even if their initial bid was higher. In this example, the cumulative demand at the winning price exactly equals the supply. If the total demand at this price were greater than the supply, all auction participants who bid prices higher than the winning price would receive their full bid (at the winning price). Shares would be awarded on a pro rata basis to bidders who bid exactly the winning price.
EVALUATE
Although the auction IPO does not provide the certainty of the firm commitment, it has the advantage of using the market to determine the offer price. It also reduces the underwriter’s role and, consequently, fees.
| Price ($) | Number of Shares Bid |
| 8.00 | 25,000 |
| 7.75 | 125,000 |
| 7.50 | 200,000 |
| 7.25 | 350,000 |
| 7.00 | 500,000 |
| 6.75 | 775,000 |
| 6.50 | 900,000 |