Reference no: EM132596608
Company executives face a dilemma. They seek new capital to fund expansion initiatives. Common shares are expected to continue to rise sharply in market price, but this would not be the time to issue new stock. Yet interest rates are also high relative to historical interest rates, and the Company currently holds a lowly B bond rating. A debt issue would be quite costly.
Address the following:
One possibility is to issue a bond with warrants. The current stock price is $20. A 20-year annual coupon bond without warrants would require 10% interest. Suppose 45 warrants were attached to the bond, each with an exercise price of $25, to each $1000 bond. Suppose also each warrant could be separated and traded individually at a value of $3
a. What coupon rate should be set on the bond with warrants if the total package is to sell at par (that is, $1000).
b. Suppose the bonds were issued and the warrants immediately traded on the open market for $5 each ... what would that imply about the terms of the issue? Did the company win or lose on their issue? Why do you say this?
c. When would you expect the warrants to be exercised? Assume the warrants have a 10-year life- the expire ten years after issue.
d. Will the warrants bring in additional capital when exercised? If so, how much and what type of capital?