Maese Industries had warrants outstanding that permit the holders to purchase on

Question

Maese Industries had warrants outstanding that permit the holders to purchase one share of stock per warrant at a price of $25. We are to assume the firms stock now sells for $20 per share. The company wants to sell some 20-year, $1000 par value bonds with interest paid annually. Each bond will have attached 50 warrants, eac exercisable into one share of stock at an exercise price of $25. The firms straight bond 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 bonds with warrants if they are to clear the market? The convertible bond should have an initial price of $1000

Explanation / Answer

step1:

value of package = value of bond + value of warrants

1000 = value of bond + 50 * 3

value of bond = 850

step2:

value of bond = coupon payment per period * PVIFA(r%,n) + face value * PVIF(r%,n)

where r = bond yield per period

n = number of periods

=>

850 = C * PVIFA(12%,20) + 1000 * PVIF(12%,20)

=>

850 = C * (7.4694) + 1000 * 0.1037

C = 99.91

coupon interest rate = 99.91/1000 = 9.99 %

dollar coupon amount = $99.91

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