Hop-In Food Stores Inc.
Hop-In Foods Stores has historically been able to rely on internal financing and long term debt in order to continue its growth. The continued growth is attributed to acquisitions of already established stores. Hop-In management has predominantly stayed away from starting up new stores from scratch due to high start up costs. They had found out that it was easier and more cost effective to buy up smaller stores in good locations. As of 1976 all of Hop-In’s expansion was financed by long term debt or equity shed out by upper management. Prior to 1976, Hop-In had had common shares outstanding, but was primarily traded only in Virginia. In order to continue the growth and expansion that management wanted they had to come up with additional funds.
Equity financing was the answer to the Hop-In Food Stores need for the additional monies needed to cover growth costs. One of the main risks of IPO offerings is the risk of underpricing. This can be costly to both Hop-In and the investment bank. If the market decides that Hop-In’s value is worth more than initially offered stock prices with rise, leaving additional money that could have been raised by the company. This money “left on the table” could have been used to finance other investments or pay down any outstanding debts. The investment bank takes on the risk from the standpoint that they did not properly value the stock price. The underpricing of stock means that they did not maximize the money Hop-In could have raised. The reputation of not properly valuing IPO prices can lead to lost future business.
In order to determine Hop-In’s new issue price, Mr. Merriman must first forecast the next five years of free cash flows. He should first create pro forma balance sheets and income statements. Once the financial have been forecasted the next step is to figure out what free cash flows are. This can be by multiplying EBIT*(1-tax), adding back depreciation, subtracting the change in capital...
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