# Underpricing

Suppose Primerica has just paid a dividend of \$1.75 per share. Sales and profits for Primerica are expected to grow at a rate of 5% per year. Its dividend is expected to grow by the same amount. If the required return is 12%, what is the value of a share of Primerica in 6 years? 7) IPOs typically experience underpricing.

Describe (1) what is underpricing, (2) the evidence that underpricing occurs (be sure to include real world numbers/examples), and (3) why does underpricing occur.

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) Adelson’s Electric had beginning long-term debt of \$42,511 and ending long-term debt of \$48,919. The beginning and ending total debt balances were \$84,652 and \$78,613, respectively. The interest paid was \$4,767.

What is the amount of the cash flow to creditors?

) You arrived at work today to see the CFO, COO and most of the company’s top management team taken away in handcuffs. The only executive who was not arrested was the newly appointed CEO. Before you can even reach your cube, the CEO calls you into his office to explain some incomplete project analysis left on the CFO’s desk. Below are the two mutually exclusive projects under consideration. Year Project A Project B 0 (171,000.00) (198,000.00) 1 46,000.00 55,000.00 2 79,000.00 34,000.00 3 51,000.00 120,000.00 4 65,000.00 25,000.00 5 23,000.00 75,000.00 IRR 17.82% 16.22% While a marketing genius, the CEO has very little experience in finance, and would like to simply choose ‘Project A’ because “it earns a higher return for the company.”

a. Explain (in words and graphically) why the CEO’s reasoning could be flawed.

b. If your firm has a cost of capital of 8%, how much value will the firm lose out on by choosing the project with the highest IRR?

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