One of the firms alternatives is to issue a bond with warrants attached. Edusofts current stock price

Question:

One of the firm’s alternatives is to issue a bond with warrants attached. Edusoft’s current stock price is $20, and its investment banker estimates that the cost of a 20-year, annual coupon bond without warrants would be 12 percent. The bankers suggest attaching 50 warrants, each with an exercise price of $25, to each $1,000 bond. It is estimated that each warrant, when detached and traded separately, would have a value of $3. What coupon rate should be set on the bond with warrants if the total package is to sell for $1,000?

MINI CASE

Paul Duncan, financial manager of Edusoft Inc., is facing a dilemma. The firm was founded five years ago to provide educational software for the rapidly expanding primary and secondary school markets. Although Edusoft has done well, the firm’s founder believes that an industry shakeout is imminent. To survive, Edusoft must grab market share now, and this will require a large infusion of new capital. Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it would be wise to issue new at this time. On the other hand, interest rates are currently high by historical standards, and with the firm’s B rating, the interest payments on a new debt issue would be prohibitive. Thus, he has narrowed his choice of financing alternatives to two securities: (1) with warrants or (2) convertible As Duncan’s assistant, you have been asked to help in the decision process by answering the following questions:

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Bonds
When companies need to raise money, issuing bonds is one way to do it. A bond functions as a loan between an investor and a corporation. The investor agrees to give the corporation a specific amount of money for a specific period of time in exchange... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a...