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Chapter 5: Q19-9DQ (page 622)

Explain why warrants are issued. (Why are they used in corporate finance?)

Short Answer

Expert verified

Warrants are utilized to improve a debt offering or a bankruptcy proceeding, or as part of a merger offer. These are generally issued to attract investors to the market for purchasing the securities issued.

Step by step solution

01

Step 1:Introduction of warrant

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.

02

Reason to issue warrants

  1. Additional capital can be raised by the business entity without any additional issue of the securities.
  2. It is a capitalization option for business entities.

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Most popular questions from this chapter

The Ellis Corporation has heavy lease commitments. Prior to SFAS No. 13, it merely footnoted lease obligations in the balance sheet, which appeared as follows:

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

The footnotes stated that the company had $14 million in annual capital lease obligations for the next 20 years.

e. In an efficient capital market environment, should the consequences of SFAS No. 13, as viewed in the answers to parts c and d, change stock prices and credit ratings?

Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.

b. Why is the investment banker selling the stock at less than its current market price?

Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.

a. How many shares of stock must be sold to net $21,120,000? (Note: No out-of-pocket costs must be considered in this problem.)

American Health Systems currently has 6,400,000 shares of stock outstanding and will report earnings of \(10 million in the current year. The company is considering the issuance of 1,700,000 additional shares that will net \)30 per share to the corporation.

a. What is the immediate dilution potential for this new stock issue?

b. Assume that American Health Systems can earn 9 percent on the proceeds of the stock issue in time to include them in the current year鈥檚 results. Calculate earnings per share. Should the new issue be undertaken based on earnings per share?

The Wrigley Corporation needs to raise \(44 million. The investment banking firm of Tinkers, Evers & Chance will handle the transaction.

  1. If stock is utilized, 2,300,000 shares will be sold to the public at \)20.50 per share. The corporation will receive a net price of \(19 per share. What is the percentage underwriting spread per share?
  2. If bonds are utilized, slightly over 43,700 bonds will be sold to the public at \)1,009 per bond. The corporation will receive a net price of $994 per bond. What is the percentage of underwriting spread per bond? (Relate the dollar spread to the public price.)
  3. Which alternative has the larger percentage of spread? Is this the normal relationship between the two types of issues?
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