Q19-17BP The Redford Investment Company b... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 5: Q19-17BP (page 626)

The Redford Investment Company bought 100 Cinema Corp. warrants one year ago and would like to exercise them today. The warrants were purchased at $24 each, and they expire when trading ends today (assume there is no speculative premium left). Cinema Corp. common stock is selling today for $50 per share. The exercise price is $30 and each warrant entitles the holder to purchase two shares of stock, each at the exercise price.
a. If the warrants are exercised today, what would the Redford Investment Company鈥檚 dollar profit or loss be?
b. What is the Redford Investment Company鈥檚 percentage rate of return?

Short Answer

Expert verified

a) Profit is $1,600

b) Rate of return is 66.7%

Step by step solution

Meaning of Warrants

The business entity adopts a method for attracting investors under which the investors are given rights to purchase the securities of the business entity in a future period before expiry dates. These rights are defined as warrants.

Computing Redford Investment Company’s dollar profit or loss

Calculation of Intrinsic value of warrant

The market value of the common stock	$50
Less: The exercise price of the warrant	$30
(A)	20
No. of shares each warrant entitles the holder to purchase (B)	2
The intrinsic value of a warrant	$40

Calculation of proceeds from the sale

$\begin{matrix} P r o c e e d s 鈥� f r o m 鈥� s a l e = I n t r i n s i c 鈥� v a l u e 脳 W a r r a n t s \\ = $ 40 脳 1, 00 \\ = $ 4, 000 \end{matrix}$

Calculation of Purchase price

$\begin{matrix} P u r c h a s e 鈥� p r i c e = P r i c e 脳 W a r r a n t \\ = $ 24 脳 100 \\ = $ 2, 400 \end{matrix}$

Calculation of profit

$\begin{matrix} P r o f i t = P r o c e e d s 鈥� f r o m 鈥� s a l e - P u r c h a s e 鈥� p r i c e \\ = $ 4, 000 - $ 2, 400 \\ = $ 1, 600 \end{matrix}$

Computing the Redford Investment Company’s percentage rate of return

Calculation of rate of return

$\begin{matrix} R e t u r n = \frac{P r o f i t}{P u r c h a s e 鈥� p r i c e} \\ = \frac{$ 1, 600}{$ 2, 400} \\ = 66.7 % \end{matrix}$

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In \( millions	In \) millions
Current assets	\(70	Current liabilities	\)30
Fixed assets	\(70	Long-term liabilities	\)30
		Total liabilities	\(60
		Stockholder鈥檚 equity	\)80
Total assets	\(140	Total stockholder鈥檚 equity and liabilities	\)140

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Short Answer

Step by step solution

Meaning of Warrants

Computing Redford Investment Company’s dollar profit or loss

Computing the Redford Investment Company’s percentage rate of return

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