ACCA Advanced Financial Management (AFM) Practice Exam

What is stated about the cost of underpricing in relation to shareholder wealth?

1. The cost is minimal compared to shareholder gain

2. The cost has a significant impact on long-term wealth

3. The cost leads to decreased dividends

4. The cost is greater than the potential gains

The correct answer is: The cost is minimal compared to shareholder gain

The assertion that the cost of underpricing is minimal compared to shareholder gain highlights the perspective that initial public offerings (IPOs) often attract significant investor interest. When a company underprices its shares, it can generate substantial demand, leading to a successful market reception. This initial surge can create positive sentiment and excitement around the stock, potentially enhancing the perceived value of the company in the long run. In this context, the advantages gained from increased market visibility, investor interest, and potential future capital raises usually outweigh the short-term costs associated with leaving money on the table during an IPO. It supports the idea that while underpricing does have its costs, they are often overshadowed by the long-term benefits attained through increased shareholder loyalty and market capitalization resulting from a well-received stock launch. While other options suggest potential negative impacts, they do not capture the complete vision of the overarching benefits resulting from initial underpricing and how they can lead to better shareholder outcomes over time. Those outcomes can include larger investments from institutional investors, higher stock prices after the initial offering, and improved market conditions for future fundraising efforts, reinforcing a generally positive perception among shareholders.