Emerson Electrical Engineering Inc. is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the bond would carry an 11% interest rate. However, with the warrants attached the bonds will pay a 9% annual coupon. There are 25 warrants attached to each bond, which have a par value of $1000. The exercise price of the warrants is $25 and the expected stock price 10years from now (when the warrants may be exercised) is $50.77.

a) What is the investor's expected overall pre-tax rate of return for this bond-with-warrants issue?

b) The CEO of Emerson is wondering the possibility of replacing the bonds with warrants by convertible bonds. As the CFO for the company, please state your suggestions and explain.