Introduction to Corporate Finance

(avery) #1
Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate Edition

VI. Cost of Capital and
Long−Term Financial
Policy


  1. Raising Capital © The McGraw−Hill^553
    Companies, 2002


CHAPTER


16


Raising Capital


On July 21, 1999,MP3.com was born as a publicly traded company. On that day,
the firm completed its initial public offering, or IPO, by selling stock to the public
for the first time. The investment turned out to be a smart one for the lucky
buyers. MP3.com’s stock price closed at $63.3125 per share that first day, which
amounted to a one-day gain of 126 percent! The offering gave MP3.com the
financing it needed to grow its business, and, as you might imagine, MP3.com
was not alone. In fact, 1999 was a big year for IPOs. Even after excluding issues
with low offering prices and those with unusual features, MP3.com’s IPO was just
1 of almost 500 offerings for the year. In addition, for the year, 117 of the IPOs
doubled in value (or did better) during their first day of trading. By comparison,
in the 25 years from 1974 to 1998, only 39 IPOs doubled in value on their first
day of trading. What is more, 1999 sported the biggest one-day price gain ever,
698 percent for VA Linux shares and the then-biggest IPO ever, by United Parcel
Service (UPS). In this chapter, we will examine the process by which companies
like MP3.com, VA Linux, and UPS sell stock to the public, the costs of doing so,
and the role of investment banks in the process.

ll firms must, at varying times, obtain capital. To do so, a firm must either bor-
row the money (debt financing), sell a portion of the firm (equity financing), or
both. How a firm raises capital depends a great deal on the size of the firm, its
life cycle stage, and its growth prospects.
In this chapter, we examine some of the ways in which firms actually raise capital.
We begin by looking at companies in the early stages of their lives and the importance
of venture capital for such firms. We then look at the process of going public and the
role of investment banks. Along the way, we discuss many of the issues associated with
selling securities to the public and their implications for all types of firms. We close the
chapter with a discussion of sources of debt capital.^1

A


(^1) We are indebted to Jay R. Ritter of the University of Florida for helpful comments and suggestions on this
chapter.
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