ABC just issued $25 million worth of 10 year bonds with warrants attached. Each

Question

ABC just issued $25 million worth of 10 year bonds with warrants attached. Each bond has 40 warrants attached, and each warrant allows its owner to purchase one share of common stock. The warrants mature in 6 years, have a premium of $2.5, and carry an exercise price of $20. Suppose that a bond-with-warrants package was issued at par when the yield to maturity was 15%. ABC's total value of operations and investments is $900 million and the firm currently has 50 million shares outstanding. The company's value is expected to grow at a 7% rate for the forseeable future. ABC is in the 40% tax bracket.

Find the total value of the warrants associated with each bond.

Find the value of the firm (in terms of millions) when the warrants expire.

Find the after-tax cost of the company's vanilla bonds.  

Find the IRR of the warrants.  

Find the after-tax cost of the bonds-with-warrants.

Round intermediate steps and your final answer to four decimals.  

Explanation / Answer

Answer:

1.The total value of warrants attached with each bond is= Since there are bonds with the exercise price of $20 and premium of $2.5. The price of warrant $20+$2.5=$22.5. The total value of warrant associated with bonds is 40*$22.5=$900.

2. if the warrant expire the total value of the firm is

Total firm value is Bond value +security value=$900 million

Bond =$25 million Stock =$900-$25=$875 million

Bonds value when warrant expire=$2500000-900=$2499100

Assume all the investment in stock =$875000000/50,00000=$17.5

when the warrant expire that means 40 warrant at $17.5=40*22.5-40*17.5=$200

Total value of firm is $2499100+$875000000-$200=$877 million

3. After tax cost of company plain vanilla bond

Bond =$25000000-900=$2499100

Interest rate=$2499100*0.15=$374865

Tax saving would be= $374865*0.40=$144946

After tax saving in debt would be=$374865-$144946=$224919 and the after-tax cost would be=$224919/$2499100= 9%

4 IRR of the warrant would be

=22.5*40-17.5*40=900-700=200/900*100=22.22%

5. After-tax cost of plain vanilla bond with warrants

YTM=15%

Bond value=$25,000000

Tax rate 40%

Interest paid=$25,000000*0.15=$375000

Tax saving would be =$375000*0.40=$1500000

The after-tax cost of debt saving is $375000-$1500000=$2250000 after cost debt is $2250000/$25000000 is 9%.

4. The IRR of the warrants is

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