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Warrants Srorm Software wants to issue $80 million ($800 x 100,000 bonds) in new capital to...

Warrants Srorm Software wants to issue $80 million ($800 x 100,000 bonds) in new capital to fund new opportunities. If Storm raised the $80 million of new capital in a straight-debt 20-year bond offering, Storm would have to offer an annual coupon rate of 11%. However, Storm's advisers have suggested a 20-year bond offering with warrants. According to the advisers, Storm could issue 7% annual coupon-bearing debt with 20 warrants per $800 face value bond. Storm has 10 million shares of stock outstanding at a current price of $30. The warrants can be exercised in 10 years (on December 31, 2025) at an exercise price of $35. Each warrant entitles its holder to buy one share of Storm Software stock. After issuing the bonds with warrants, Storm's operations and investments are expected to grow at a constant rate of 10.6% per year. If investors pay $800 for each bond, what is the value of each warrant attached to the bond issue? Round your answer to the nearest cent. $ What is the component cost of these bonds with warrants? Round your answer to two decimal places. % What premium is associated with the warrants? Round your answer to two decimal places. %

Expert Solution

Firm's appropriate cost of debt = 11% = coupon on straight bond = discount rate = K.

Let' figure out the market price for a straight bond with 7% coupon rate.

Face Value, FV = $ 800

Payment = Coupon paid annually = 7% x FV = 7% x 800 = $ 56

Period = 20 years

Discount Rate = Firm's appropriate cost of debt = 11% = coupon on straight bond

Price of this bond = -PV(Rate, period, Payment, FV) = - PV(11%, 20, 56, 800) = $ 545.17

If investors pay $800 for each bond with 20 warrants then

Implied value of 20 warrants = Price of bond with warrant - Price of straight bond without warrant = 800 - 545.17 = $254.83

The value of each warrant attached to the bond issue = 254.83 / 20 = $ 12.74

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What is the component cost of these bonds with warrants? Round your answer to two decimal places.

Value of bond with warrants, B = $ 800.00
Value of straight bond portion, B_S = $ 545.17
Value of warrants, B_W = $ 254.83
% straight bond = B_S / B = 545.17 / 800 = 68.15%
% warrants = B_W / B = 254.83 / 800 = 31.85%

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What premium is associated with the warrants? Round your answer to two decimal places. %

Premium associated with the warrants = Theoretical price of warrant - Minimum Price

Minimum price = Strike price - current stock price = 4 35 - $ 30 = $ 5

Hence premium = $ 12.74 - $ 5 = $ 7.74

jeff jeffy answered 2 years ago

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