1.You have an arrangement with your broker to request 4000 shares of all available IPOs. Suppose that 20% of the time, the IPO is "very successful" and appreciates by 100% on the first day, 70% of the time it is "successful" and appreciates by 10%, and 10% of the time it "fails" and falls by 20%.

a.By what amount does the average IPO appreciate on the first day? In other words, what is the average IPO underpricing?

b.Suppose that you expect to receive 200 shares when the IPO is very successful, 800 shares when it is successful, and 4000 shares when it fails. Assume that the average IPO price is $20. What is your expected one-day return on your IPO investments?

2.White Corp. and Black Inc. are considering a merger. The two possible states of the economy and the information pertaining to the values of the two firms are shown below:

State

Probability

Black

White

Boom

70%

$400,000

$300,000

Recession

30%

$120,000

$100,000

Black currently has a bond issue outstanding with a face value of $150,000. White is an all-equity firm.

a.What is the value of each firm before the merger? What is the total value of the two firms before the merger?

b.What are the values of each firm's debt and equity before the merger?

c.What would be the value of the merged firm? What would be the values of the merged firm's debt and equity?

d.Should the shareholders of two firms approve the merger? Explain why.