MPF753 Finance – Assignment 2 (Brief: IPO Underpricing and DDM Valuation)

Unit Context

Faculty: Deakin Business School – Deakin Graduate School of Business

Unit: MPF753 Finance (Masters level core finance unit)

Assessment Title: Assignment 2 – IPO Underpricing and Equity Valuation

Assessment Type: Applied quantitative report consisting of Part A and Part B

Weighting: 30 percent of final unit grade

Length: 2,500 words in total, approximately 1,500 words for Part A and 1,000 words for Part B, excluding tables, figures, appendices and reference list

Administrative Details

Due Date: Week 9, Monday, 11:59 pm AEST, submitted via CloudDeakin Assignment Dropbox with Turnitin enabled

• Extensions: Requests must be made in writing to the Assignment Coordinator before the due date with appropriate documentary evidence attached.

• Group Work: The assignment may be completed individually or in groups of two. Students enrolled in MPF953 must submit individually.

• Group Registration: Groups of one or two students must be registered through the Groups link in CloudDeakin by the Week 8 deadline. Late registration may incur a mark penalty.

Submission Requirements

• Submit one Word document only through CloudDeakin. Email submissions or hard copies will not be accepted.

• Embed any Excel workings into the Word document so that clicking tables opens the original spreadsheet.

• Name the file using student identification numbers only, for example 1234567.docx or 1234567_7654321.docx.

• Use Harvard or APA referencing consistently for all data sources and academic literature.

• Turnitin originality checking is enabled and subsequent submissions before the deadline will overwrite earlier versions.

• All submissions must comply with the University Academic Integrity Policy. Suspected plagiarism or collusion will be referred for formal review.

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Deakin Graduate Learning Outcomes Addressed

• Discipline Specific Knowledge and Capabilities: Apply core finance theories to IPO underpricing and equity valuation in real market contexts.

• Digital Literacy: Use financial databases such as Morningstar DatAnalysis, ASX announcements and Yahoo Finance to source, analyse and interpret financial information.

Part A – Case Study: IPO Underpricing in Australia

Length: Maximum 1,500 words excluding tables, figures, appendices and references
Marks: 18 marks

Background

Highly publicised listings such as Facebook’s May 2012 initial public offering, which raised around USD 16 billion but generated only a small first day price increase, renewed debate about whether new issues are systematically mispriced. While short-run underpricing is widely documented in the United States, Australian evidence also indicates substantial first-day positive returns, although the extent and causes may differ due to institutional features of the Australian Securities Exchange.

Task Overview

You are employed as the chief financial analyst at Goo-Du Company, a private internet services firm considering listing on the ASX. The Chief Executive Officer is concerned that recent disappointing IPOs may discourage shareholders from supporting a public offering. You are required to prepare a written analytical report examining short-run IPO performance and longer-term returns in the Australian market. The analysis must rely on real IPO data and appropriate descriptive statistics and must be supported by academic literature.

Question 1 – Short-Run IPO Performance in Australia (6 Marks)

Investigate whether short-run IPO underpricing exists in the Australian market using IPOs listed on the ASX over a recent six-month window that remain listed up to their two-year anniversary.

1. From Morningstar DatAnalysis or an equivalent database, download a list of ASX IPOs in your chosen period including:

   • Company name and ASX code

   • Initial offering price

   • First trading day adjusted closing price

2. Compute the short-run initial return for each IPO using the standard formula:

   Initial Return equals first day price minus issue price divided by issue price multiplied by one hundred.

3. Provide descriptive statistics such as mean, median, minimum, maximum and standard deviation for the initial returns. Summarise key insights regarding the presence and magnitude of underpricing.

4. Group the IPOs using at least three variables such as industry sector, offer size or underwriter reputation and report how initial returns differ across groups. Clearly justify the choice of grouping variables.

Question 2 – Two-Year Post-Listing Performance (4 Marks)

Evaluate how the IPOs in your sample perform over the two-year period following listing.

1. Obtain the adjusted closing price on the two-year anniversary of each listing date.

2. Calculate the two-year holding period return using the formula:

   Two-year holding period return equals anniversary price minus first day price divided by first day price multiplied by one hundred.

3. Using the same grouping variables as in Question 1, compare the distribution of two-year returns with initial returns and comment on any patterns or relationships.

Question 3 – Theories of IPO Underpricing (6 Marks)

Select and discuss two theories that you believe provide the most convincing explanations for short-run IPO underpricing. Examples include information asymmetry models, signalling theories, litigation risk, underwriter incentives or behavioural explanations.

• Briefly describe each chosen theory.

• Explain how each theory accounts for observed patterns of IPO underpricing.

• Support the discussion with at least three academic references from peer-reviewed journals or finance textbooks.

Question 4 – Referencing (2 Marks)

Use consistent Harvard or APA referencing for all data sources and literature cited in Part A. Marks are allocated specifically for the accuracy and quality of referencing.

Part B – Valuation Using the Dividend Discount Model

Length: Maximum 1,000 words excluding tables, figures and references
Marks: 12 marks

Task Overview

Select an ASX-listed company that has been paying dividends for at least seven years and estimate a theoretical share price using a constant growth Dividend Discount Model. You must then compare this valuation with the current market price and discuss possible reasons for any differences.

Data Collection

• Choose an ASX company with at least seven consecutive years of dividend payments and clearly state its name, code and sector.

• Obtain seven years of annual dividend data from reliable sources such as Morningstar DatAnalysis, ASX announcements or Yahoo Finance.

• Record the current market share price on a clearly specified valuation date.

Estimation Requirements

Dividend Growth Rate

• Estimate a constant dividend growth rate using an appropriate method such as average historical growth or regression analysis.

• Explain and justify the chosen method and show full workings used to derive the growth rate.

Cost of Equity

• Identify around ten comparable peer firms from the same industry and obtain their net profit after tax and shareholders’ equity.

• Calculate each firm’s return on equity and compute the average as a proxy for the sector cost of equity.

• Present all calculations clearly.

DDM Valuation and Reconciliation

• Apply the constant growth Dividend Discount Model:

  Theoretical price equals next period dividend divided by the difference between cost of equity and growth rate.

• Compare the theoretical price with the actual market price and discuss reasons for any discrepancies such as non-constant growth, risk mismeasurement or market sentiment.

Referencing

Accurately reference all data sources and academic material used in Part B using Harvard or APA style.

Marking Guide Summary

Empirical finance research consistently demonstrates that IPO markets are influenced not only by firm fundamentals but also by investor sentiment, information availability and market structure. Analysts therefore need to approach IPO data with care, recognising that high first-day returns do not necessarily indicate long-term investment quality. Understanding both statistical evidence and theoretical explanations enables more balanced conclusions about whether underpricing represents inefficiency or a rational response to uncertainty (Ritter 1991).

 Academic and Professional References

• Perera, H 2016, New evidence of short-run underpricing in Australian IPOs, IMFI Working Paper, Victoria University.

• Lowry, M, Michaely, R & Volkova, E 2022, The 7 percent solution and IPO underpricing, Journal of Financial Economics.

• Lee, PJ, Taylor, SL & Walter, TS 1996, Australian IPO pricing in the short and long run, Journal of Banking and Finance.

• OpenStax 2022, Dividend Discount Models, in Principles of Finance.

• Damodaran, A 2019, The Little Book of Valuation, Wiley.

• Ritter, JR 1991, The long-run performance of initial public offerings, Journal of Finance, vol. 46, no. 1, pp. 3–27.