A firm has issued 500 shares of stock, 100 warrants and a straight bond. The warrants are about to expire and all of them will be exercised. Each warrant entitles the holder to 5 shares at $25 per share. The market value of the firm’s assets is 25,000. The market value of the straight bond is 8,000. That of equity is 15,000.

1. Determine the post–exercise value of a share of equity.

2. What is the mispricing of equity?

3. From the proceeds of immediate exercise, value the warrant.

4. Now assume that the market value of debt becomes $9,000, to reflect the increase in the value of the firm upon warrant exercise (which lowers the probability of bankruptcy). Re–compute the value of the warrants and of equity.