Question

ABC Company is planning to issue 20,000 bonds with warrants attached. The bonds will make annual interest payments of 6.8% and will have a 20-year maturity. There will be 75 warrants attached to each bond, with each warrant giving the right to purchase one share of stock at a price of $12. A similar straight-debt issue would require a 10% coupon rate. Total assets before issuance equal $120 million, with $50 million of liabilities. What is the value of the warrants when the bond and warrants are initially issued?

Answer 1

Assuming the face value of each bond is 100 and that the bonds are issued at FV

If the rate on staright bonds is 10% and the rate on our issue is 6.8% we have a saving of 3.2 % in interest cost that savings is the value of our warrant

in order to find the value of these savings we have to find the PV of that 3.2%

Total FV of bonds 20000 * 100 = 2000000

Savings per year = 2000000 * 3.2% = 64000

Find the PV of annuity of 64000 using PV function in excel we get 544868 for 20 years (the discount rate is assumed equal to the prevailing coupon rate of 10%)

If we divide this value of savings by number of warrants issued we will find the value of each warrant

no. of warrants isued 75*20000 = 1500000

Value of each warrant = 544868/1500000 = 0.3632