Bundle: Fundamentals of Financial Management, 14th + MindTap Finance, 1 term (6 months) Printed Access Card
Bundle: Fundamentals of Financial Management, 14th + MindTap Finance, 1 term (6 months) Printed Access Card
14th Edition
ISBN: 9781305777118
Author: Eugene F. Brigham, Joel F. Houston
Publisher: Cengage Learning
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Chapter 20, Problem 6P

a.

Summary Introduction

To Determine: The exercise value of Company PII’s warrants if the common stock sells at $18, $21, $25 and $70.

Introduction: A warrant is securities that give the bondholder the right, yet not the obligation, to purchase a specific number of securities at a specific cost before a specific time. Warrants are not the equivalent as the call options or purchase rights of the stock.

a.

Expert Solution
Check Mark

Answer to Problem 6P

The exercise value of Company PII’s warrants if the common stock sells at $18 is -$3, $21 is $0, $25 is $4 and $70 is $49.

Explanation of Solution

Determine the exercise value of company PII’s warrants

If the common stock sells at $18

ExercisePriceIfStockPriceis$18=[CurrentPriceStrikePrice]=[$18$21]=$3

If the common stock sells at $21

ExercisePriceIfStockPriceis$21=[CurrentPriceStrikePrice]=[$21$21]=$0

If the common stock sells at $25

ExercisePriceIfStockPriceis$25=[CurrentPriceStrikePrice]=[$25$21]=$4

If the common stock sells at $70

ExercisePriceIfStockPriceis$70=[CurrentPriceStrikePrice]=[$70$21]=$49

Therefore the exercise value of Company PII’s warrants if the common stock sells at $18 is -$3, $21 is $0, $25 is $4 and $70 is $49.

b.

Summary Introduction

To Determine: The approximate price and the premium implied the warrants to sell under each condition from part (a) based on guess or reasonable assumption.

b.

Expert Solution
Check Mark

Explanation of Solution

Determine the approximate price, premium and warrant for each stock

Since there is no exact or approximate solutions are possible the below are the price, premium and warrant for each stock price which are purely based on reasonable assumption.

If the common stock sells at $18:

The approximate price will be $18, the premium will be $4.50 and the warrant will be $1.50.

If the common stock sells at $21:

The approximate price will be $21, the premium will be $3 and the warrant will be $3.

If the common stock sells at $25

The approximate price will be $25, the premium will be $1.50 and the warrant will be $5.50.

If the common stock sells at $70:

The approximate price will be $70, the premium will be $1 and the warrant will be $50.

c1.

Summary Introduction

To Determine: The factors that affect the estimates of the warrants' prices and premium in part b when the life of warrant in lengthened.

c1.

Expert Solution
Check Mark

Explanation of Solution

The factors that affect the estimates of the warrants' prices and premium in part b when the life of warrant in lengthened is as follows:

The higher the value of warrant, the lengthier the life of the warrant.

c2.

Summary Introduction

To Determine: The factors that affect the estimates of the warrants' prices and premium in part b when the expected variability in stock's price decrease.

c2.

Expert Solution
Check Mark

Explanation of Solution

The factors that affect the estimates of the warrants' prices and premium in part b when the expected variability in stock's price decrease is as follows:

The lesser the value of warrant, the lesser the variable of the stock price.

c3.

Summary Introduction

To Determine: The factors that affect the estimates of the warrants' prices and premium in part b when the growth rate in the stock's EPS increase.

c3.

Expert Solution
Check Mark

Explanation of Solution

The factors that affect the estimates of the warrants' prices and premium in part b when the growth rate in the stock's EPS increase is as follows:

The greater the price of warrant, the greater the expected EPS growth rate.

c4.

Summary Introduction

To Determine: The factors that affect the estimates of the warrants' prices and premium in part b when the company paid no dividends and will pay out all earnings as dividends.

c4.

Expert Solution
Check Mark

Explanation of Solution

The factors that affect the estimates of the warrants' prices and premium in part b when the company paid no dividends and will pay out all earnings as dividends is as follows:

Beginning from 0 to 100% payout would have two conceivable impacts. To start with, it may influence the price of stock creating an variation in the exercise value of the warrant, nonetheless, it is not certain that the price of stock would change, not to mention what the variations possible.

The expansion in the payout ratio would significantly bring down the expected growth rate. This would decrease the probability of the stock's cost expanding in the future. This would bring down the expected value of the warrant, consequently bring down the premium and the cost of the warrant.

d.

Summary Introduction

To Determine: The annual coupon interest rate and annual dollar coupon on the bonds.

d.

Expert Solution
Check Mark

Answer to Problem 6P

The annual coupon interest rate is 9.11% and annual dollar coupon on the bonds is $91.19.

Explanation of Solution

Determine the value of bond

ValueofBond=[FaceValue(ValueofWarrant×NumberofWarrants)]=[$1,000($1.50×50)]=[$1,000$75]=$925

Therefore the value of bond is $925.

Determine the annual dollar coupon on the bonds

Using an excel spreadsheet and excel function =PMT, the annual dollar coupon on the bonds is calculated as $91.19.

Excel Spreadsheet:

Bundle: Fundamentals of Financial Management, 14th + MindTap Finance, 1 term (6 months) Printed Access Card, Chapter 20, Problem 6P

Therefore the annual dollar coupon on the bonds is $91.19

Determine the annual coupon interest rate on the bonds

AnnualCouponRate=[CouponPaymentFaceValue]=[$91.19$1,000]=0.09119or9.11%

Therefore the annual coupon interest rate on the bonds is 9.11%.

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Maese Industries Inc. has warrants outstanding that permit the holders to purchase 1 share of stock per warrant at a price of $25. a. Calculate the exercise value of a warrant at each of the following common stock 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. Assume the firm’s stock now sells for $20 per share. The company wants to sell some 20-year, $1,000 par value bonds with interest paid annually. 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%. 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? (Hint: The convertible bond should have an initial price of $1,000.)
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