Ch19MiniCase

Ch19MiniCase - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Ch 19 Mini Case 3/11/2003 Chapter 19. Mini Case for Hybrid Financing: Preferred Stock, Warrants, and Convertibles Value Package = Value Bonds + Value Warrents = $1,000 Value Package = Value Bonds + 50($3) = $1,000 Value Package = Value Bonds + $150 = $1,000 Value Bonds = $1,000 - $150 Value Bonds = $850 N 20 I 12% PV $850 FV $1,000 Payment $100 (1) What coupon rate should be set on the bond with warrants if the total package is to sell for $1,000? Coupon Rate 10% Value Package = Value Bonds + Value Warrents Value Package = $850 + 50($5) Value Package = $850 + $250 Value Package = $1,100 At issue, the package was actually worth $1,100 which is $100 more than the selling price. So, the company lost. Paul Duncan, financial manager of Edusoft Inc., is facing a dilemma. The firm was founded five years ago to provide educational software for the rapidly expanding primary and secondary school markets. Although Edusoft has done well, the firm's founder believes that an industry shakeout is imminent. To survive, Edusoft must grab market share now, and this will require a large infusion of new capital. Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it would be wise to issue new common stock at this time. On the other hand, interest rates are currently high by historical standards, and with the firm's B rating, the interest payments on a new debt issue would be prohibitive. Thus, he has narrowed his choice of financing alternatives to two securities: (1) bonds with warrants or (2) convertible bonds. As Duncan's assistant, you have been asked to help in the decision process by answering the following questions: a. How does preferred stock differ from both common equity and debt? Is preferred stock more risky than common stock? What is floating rate preferred stock? Answer: See Chapter 19 Mini Case Show b. What is a call option? How can a knowledge of call options help a financial manager to better understand warrants and convertibles? Answer: See Chapter 19 Mini Case Show c. One of the firm's alternatives is to issue a bond with warrants attached. EduSoft's current stock price is $20, and its investment banker estimates that the cost of a 20-year, annual coupon bond without warrants would be 12 percent. The bankers suggest attaching 50 warrants, each with an exercise price of $25, to each $1,000 bond. It is estimated that each warrant, when detached and traded separately, would have a value of $3. (2) Suppose the bonds were issued and the warrants immediately traded on the open market for $5 each.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 5

Ch19MiniCase - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online