FM11_Ch_21_Tool_Kit

# FM11_Ch_21_Tool_Kit - A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15...

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

7/3/2003 Chapter 21. Tool Kit for Hybrid Financing: Preferred Stock, Warrants, and Convertibles PREFERRED STOCK Problem A firm has sold 150,000 shares of \$100 par value perpetual preferred stock (the total issue is \$15 million). The preferred stock has a stated annual dividend of \$12 per share. What is the dividend yield? Par value = \$100 \$12 Dividend yield = 12% WARRANTS Problem Price of the 8% coupon bonds N 20 Price paid = \$1,000 I 10% CPN % 8% Total funds to be raised= \$50,000,000 FV \$1,000 Total number of bonds= 50,000 CPN PMT \$80 Warrants per bond = 20 Total no. of warrants = 1,000,000 Price = \$829.73 In this model, we will examine three sources of long-term capital: preferred stock, warrants, and convertibles. Preferred stock is a hybrid security that represents a cross between debt and common equity. Warrants are derivative securities used by firms. Lastly, convertible securities are hybrids between debt and warrants. Commonly, preferred stock has a par value of \$25 or \$100. A preferred dividend is indicated as a percentage of par, or as dollars per share. Since preferred stock pays a perpetual dividend, its value is derived as the preferred dividend divided by the cost of preferred stock. Preferred stock's dividend yield, like common stock is the dividend paid divided by the value of the stock. D PS = A warrant is a certificate issued by a company which gives the warrant holder the right to buy a stated number of 'shares of the company's stock at a specified price for some specified length of time. Such warrants are called long-term call options, because they offer investors the opportunity to buy the firm's common stock at a fixed price, regardless of how high the stock may climb. This option offsets a low interest rate on a bond and can make a low-yield bond/warrant package more appealing to investors. A corporation decides to issue 20 year bonds to fund a \$50 million expansion. If they were to issue a straight bond 'package, the bonds would carry a 10% coupon rate, however the current bond proposal calls for an 8% coupon and 'stock warrants. Thus, investors will be paying \$1,000 in return for the 8% coupon, 20-year bond and 20 warrants '(the exercise price of the warrants is \$22). What is the implied value of each warrant? To find the implied value of each warrant, we must first determine the total value of this call option. The value of the option can be determined as the difference in price between the 8% coupon bond being issued, discounted by 10%. We use a 10% discount rate, because it is the true measure of the firm's cost of debt, and it accurately reflects the riskiness of these bonds.

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

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern