Question

The Woods Co. and the Speith Co. have both announced IPOs at $69 per share. One of these is undervalued by $16, and the other is overvalued by $6, but you have no way of knowing which is which. You plan to buy 1,800 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled.a.If you could get 1,800 shares in Woods and 1,800 shares in Speith, what would your profit be? (Do not round intermediate calculations.)b. What profit do you actually expect? (Do not round intermediate calculations.)

Answer 1

Answer:

(a) $18,000

(b) $3,600

Explanation:

(a) Profit would be:

= (No. of shares × Undervalued) - (No. of shares × Overvalued)

= (1,800 × $16) - (1,800 × $6)

= $28,800 - $10,800

= $18,000

(b) Only half your order will be filled.

With rationing (and being an uninformed investor) we expect our profits:

= (No. of shares × Undervalued) - (No. of shares × Overvalued)

= (900 × $16) - (1,800 × $6)

= $14,400 - $10,800

= $3,600