1. Neubert Enterprises recently issued $1,000 par value 15-year bonds with a 5% coupon paid annually and warrants attached. These bonds are currently trading for $1,000. Neubert also has outstanding $1,000 par value 15-year straight debt with a 7% coupon paid annually, also trading for $1,000. What is the implied value of the warrants attached to each bond?
2. Breuer investment's convertible bonds have a $1,000 par value and a conversion price of $50 a share. What is the convertible issue's conversion ratio?
3. 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 the firms warrants if the common sells at each of the following prices: (1) $20, (2) $25, (3) $30, (4) $100. (Hint: A warrants 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.)
6. The Howland Carpet Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $250,000 carrying an 8% interest rate. Howland has been 30 to 60 days late in paying trade creditors.
Discussions with an investment banker have resulted in the decision to raise $500,000 at this time. Investment bankers have assured the firm that the following alternatives are feasible (flotation costs will be ignored).
* Alternative 1: Sell common stock at $8
* Alternative 2: Sell convertible bonds at an 8% coupon, convertible into 100 shares of common stock for each $1,000 bond (i.e., the conversion price is $10 per share).
* Alternative 3: Sell debentures at an 8% coupon, each $1,000 bond carrying 100 warrants to buy common stock at $10.
John L. Howland, the president, owns 80% of the common stock and wishes to maintain control of the company. There are 100,000 shares outstanding. The following are extracts of Howland's latest financial statements:
Balance Sheet
Total Assets 550,000
Current Liabilities 400,000
Common Stock Par 1 100,000
Retaining Earning 50,000
Total Claims 550,000
Income Statement
Sales 1,100,000
All costs except interest 990,000
EBIT 110,000
Interest 20,000
EBT 90,000
Taxes (40%) 36,000
Net Income 54,000
Shares Outstanding 100,000
Earnings per share 0.54
Price/earnings ratio 15.83
Market price of stock 8.55
a.) Show the new balance sheet under each alternative. For Alternative 2 and 3 show the balance sheet after conversion of the bonds or exercise of the warrants. Assume that half of the funds raised will be used to pay off the bank loan and half to increase total assets.
b.) Show Mr. Howland's control position under each alternative, assuming that he does not purchase additional shares.
c.) What is the effect on earnings per share of each alternative, assuming that profits before interest and taxes will be 20% of total assets?
d.) What will be the debt ratio (TL/TA) under each alternative?