A firm has decided to go public by selling $10,000,000 of new common stock. Its investment bankers agreed to take a smaller fee now (7% of gross proceeds versus their normal 12%) in exchange for a 1‑year option to purchase an additional 300,000 shares at $5.00 per share. The investment bankers expect to exercise the option and purchase the 300,000 shares in exactly one year, when the stock price is fore-casted to be $4.50 per share. However, there is a chance that the stock price will actually be $10.00 per share one year from now. If the $10 price occurs, what would the present value of the entire underwriting compensation be? Assume that the investment banker’s required return on such arrangements is 18%.
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