High-Tech Fund III made a $3 million investment in Internet Printing Company (IPC) six years ago and received 2 million shares of series A convertible preferred stock. Each of these shares is convertible into two shares of IPC common stock. Three years later, High-Tech III participated in a second round of financing for IPC and received 3 million shares of series B convertible preferred stock in exchange for a $15 million investment. Each series B share is convertible into one share of IPC common stock. Internet Printing Company is now planning an IPO, but it must convert all its outstanding convertible preferred shares into common stock before the offering. After conversion, IPC will have 20 million common shares outstanding and will create another 2 million common shares for sale in the IPO. The underwriter handling IPC’s initial offering expects to sell these new shares for $45 each but has prohibited existing shareholders from selling any of their stock in the IPO. The underwriter will keep 7% of the offer as an underwriting discount. Assume that the IPO is successful and that IPC shares sell for $60 each immediately after the offering.
a. Calculate the total number of IPC common shares that High-Tech III will own after the IPO. What fraction of IPC’s total outstanding common stock does this represent?
b. Using the post-issue market price for IPC shares, calculate the (unrealized) compound annual return that High-Tech III earned on its original and subsequent investments in IPC stock.
c. Now assume that the second-round IPC financing had been made under much less favorable conditions and that High-Tech III paid only $1 million instead of $15 million for the 3 million series B shares. Assuming that all the other features of IPC’s initial offering described above hold true, calculate the (unrealized) compound annual return High-Tech III earned on this second investment in IPC stock.