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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

WARRANTS Storm Software wants to issue $100 million in new capital to fund new opportunities. If Storm raised the $100 million of new capital in a straight-debt 20-year bond offering, Storm would have to offer an annual coupon rate of 12%. However, Storm’s advisers have suggested a 20-year bond offering with warrants. According to the advisers, Storm could issue 9% annual coupon-bearing debt with 20 warrants per $1,000 face value bond. Storm has 10 million shares of stock outstanding at a current price of $25. The warrants can be exercised in 10 years (on December 31, 2025) at an exercise price of $30. Each warrant entitles its holder to buy one share of Storm Software stock. After issuing the bonds with warrants, Storm’s operations and investments are expected to grow at a constant rate of 11.4% per year.

  1. a. If investors pay $1,000 for each bond, what is the value of each warrant attached to the bond issue?
  2. b. What is the component cost of these bonds with warrants? What premium is associated with the warrants?

a.

Summary Introduction

To determine: The value of every warrant attached to the bond issue.

Introduction:

A form of long-term option mainly to purchase a specified number of shares at a particular price is termed as a Warrant. It is distributed with debts.

Explanation

Given information:

Company SS has decided to issues $100 million in a new capital for funding new opportunities. The annual coupon rate is 12 percent and the company has recommended a 20-year bond offering with the warrants. As per the advisers decision, the company can issue 9% annual coupon-bearing debt with 20 warrants per $1,000 face value bonds.

The number of stock outstanding is 10 million shares at a current price of $25 and the warrants can be exercised in 10-years period and its exercise price is $30. The constant growth rate is 11.4 percent per year.

Compute the present value of 9% bonds:

The table below shows the Excel formula to calculate the present value of 9% bonds:

The table below shows the calculated values of present value of 9% bonds:

b.

Summary Introduction

To determine: The component cost of the bonds with warrants and the premium related with the cost of warrants.

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