DRK, Inc., has just sold 100,000 shares in an initial public offering. The underwriter's explicit fees were $60,000. The offering price for the shares was $40, but immediately upon issue, the share price jumped to $44.

a. What is your best guess as to the total cost to DRK of the equity issue?

b. Is the entire cost of the underwriting a source of profit to the underwriters?

a)$460,000

b) No.

Explanation:

a) The total cost of equity issues includes explicit fees and implicit fees.

To calculate the explicit fees and implicit price is essentially calculating total cost.

The amount of explicit fees was $60,000. The implicit cost per share is the difference between the increased price (immediate) and offering price.

Calculating the implicit cost per share is then,

= $44 - $40

= $4

Implicit cost per share is $4.

To get the total implicit cost we will multiple by the no of shares.

= $4 x $100,000

= $400,000

The total cost will then be

= Equity fees + Total Implicit cost

= $60,000 + $400,000

= $460,000

b) No. Total cost of underwriting is not a profit to Underwriters as it does not included the cost of Underpricing.

If Underpricing was not included, Underwriters would charge considerably more for explicit fees.