Chapter 21
Hybrid Financing:
Preferred Stock, Warrants, and
Convertibles
SOLUTIONS TO ENDOFCHAPTER PROBLEMS
211
First issue:
20year straight bonds with an 8% coupon.
Second issue:
20year bonds with 6% annual coupon with warrants.
Both bonds issued
at par $1,000.
Value of warrants = ?
First issue:
N = 20; PV = 1000, PMT = 80, FV = 1000 and solve for I = r
d
= 8%.
(Since
it sold for par, we should know that r
d
= 8%.)
Second issue:
$1,000 = Bond + Warrants.
This bond should be evaluated at 8% (since we know the 1st issue sold at par) to
determine its present value.
Then the value of the warrants can be determined as the
difference between $1,000 and the bond’s present value.
N = 20; I = r
d
= 8; PMT = 60, FV = 1000, and solve for PV = $803.64.
Value of warrants = $1,000  $803.64 = $196.36.
213
a.
Expiration value = Current price  Striking price.
Current
Striking
Expiration
Price
Price
Value
$ 20
$25
$5 or 0
25
25
0
30
25
5
100
25
75
b.
No precise answers are possible, but some “reasonable” warrant prices are as follows:
Current
Warrant
Stock Price
Price
Premium
$20
$ 2
$ 7
25
4
4
30
7
2
100
76
1
Mini Case:
21  1
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c.
(1)
The longer the life, the higher the warrant value.
(2)
The more variable the stock price, the higher the warrant value.
(3)
The higher the expected EPS growth rate, the higher the warrant price.
(4)
Going from 0 to 100 percent payout would have two possible effects. First, it
might
affect the price of the stock causing a change in the formula value of the
warrant;
however, it is not at all clear that the stock price would change, let
alone what the change would be. Second, and more important here, the increase
in the payout ratio
drastically
lowers the expected growth rate. This reduces the
chance of the stock going up in the future. This lowers the expected value of the
warrant, hence the premium and the price of the warrant.
d.
V
Package
= $1,000 =
warrants
the
of
Value
bond
the
of
Value
debt
Straight
+
= V
B
+ 40($3)
V
B
= $1,000  $150 = $850.
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 Spring '08
 Buddin

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