Chapter 22 Convertibles, Exchangables, and Warrants

FunFinMan, Inc., is currently financed entirely with common stock. The firm is composed of $10 million in common stock ($5 par value) and $20 million in retained earnings. The company is considering issuing $20 million of 8%, 20-year debentures including 1 warrant per bond that can be converted into 5 shares of common stock at an exercise price of $40 per share. How will this impact the capitalization of the firm?

Example of Exercise of Warrants

Debentures $ 0 $ 10

Debentures $ 0 $ 10

Common stock ($5 par) 10 10

Additional paid-in capital 0 0

Retained earnings 20 20

Shareholders’ equity $ 30 $ 30

Total Capitalization $ 30 $ 40

Before After
Financing Financing
Example of Exercise of Warrants (in millions)

Debentures $ 0 $ 10

Debentures $ 0 $ 10

Common stock ($5 par) 10 10.5

Additional paid-in capital 0 3.5

Retained earnings 20 20

Shareholders’ equity $ 30 $ 34

Total Capitalization $ 30 $ 44

Before After
Financing Exercise
Example of Exercise of Warrants (in millions)

Theoretical value of a warrant:

Theoretical value of a warrant:

max [ (N)(Ps) – E, 0]

N = number of shares per warrant

Ps = market price of one share of stock

E = exercise price associated with the purchase of N shares

Warrant Value
Associated Common Stock Price
Theoretical
value line
45o
Market
value line
Exercise
price
Valuation of a Warrant

Theoretical value of a warrant: