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Warrants

Maese Industries Inc. has warrants outstanding that permit holders to purchase 1 share per warrant at a price of $25.

a. Calculate the exercise value of the firm's warrants if the common sells at each of the following prices: (1) $20, (2) $25, (3) 30, (4) $100. (Hint: A warrant's exercise value is the difference between the stock price and the purchase price specified by the warrant if the warrant were to be exercised.)

b. At what approximate price do you think the warrants would actually sell under each condition indicated above? What premium above? What premium above exercise value is implied in your price? Your answer is a guess, but your prices and premiums should bear reasonable relationships to one another.

c. How would each of the following factors affect your estimates of the warrants' prices and premiums in part b?
(1) The life of the warrant.
(2) Expected variability in the stock's price.
(3) The expected growth rate in the stock's price.
(4) The company announces a change in dividend policy: whereas it formerly paid no dividends, henceforth it will pay out all earnings as dividends.

d. Assume the firm's stock now sells for $20 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond will have attached 50 warrants, each exercisable into 1 share of stock at an exercise price of $25.

The firm's straight bonds yield 12 percent. Regardless of your answer to part b, assume that each warrant will have a market value of $3 when the stock sells at $20. What coupon interest rate, and dollar coupon, must the company set on the bonds with warrants if they are to clear the market?

Textbook answers:
a. (1) -$5 or $0
(2) $0
(3) $5
(4)$75

d. 10%; $100

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Please see the attached file.
Maese Industries Inc. has warrants outstanding that permit holders to purchase 1 share per warrant at a price of $25.

a. Calculate the exercise value of the firm's warrants if the common sells at each of the following prices: (1) $20, (2) $25, (3) 30,
(4) $100. (Hint: A warrant's exercise value is the difference between the stock price and the purchase price specified by the
warrant if the warrant were to be exercised.)

Exercise value = Maximum [ (Ps) - E, 0]
where
Ps = market price of one share of stock
E = exercise price associated with the purchase of 1 share

Ps E "Exercise Value
= Maximum [ (Ps) - E, 0]"
1) $20 $25 $0
2) $25 $25 $0
3) $30 $25 $5
4) $100 $25 $75

b. At what approximate price do you think the warrants would actually sell under each condition indicated above? What premium
above? What premium above exercise value is implied in your price? Your answer is a guess, but your prices and premiums
should bear reasonable relationships to one another.

The normal situation is for the warrant price to be quite a bit more than the exercse value.
Price of a warrant = Exercise value + Time Value

Investors are willing to pay a premium (time value) over the exercise value because of the remaining life of the warrant. As the exercise price is fixed, any future ...

Solution Summary

Solution deals with Exercise Value of Warrants, Price of Warrants, Effect of different factors (life, variability, growth rate of stock price, dividend policy) on warrant's price, coupon interest rate on the bonds with warrants that the company wishes to sell.

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