a manufacturer of video recorders, was trading at \($4\) per share in May 1994. There were 11 million shares outstanding. At the same time, it had 550,000 one-year warrants outstanding, with a strike price of \($4.25.\) The stock has had a standard deviation of 60%. The stock does not pay a dividend. The riskless rate is 5%.

a. Estimate the value of the warrants, ignoring dilution.

b. Estimate the value of the warrants, allowing for dilution.

c. Why does dilution reduce the value of the warrants?