Warrants and Convertibles Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C. Myers Slides by Matthew Will Chapter 23 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved

23- 2 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved Topics Covered  What is a Warrant?  What is a Convertible Bond?  The Difference Between Warrants and Convertibles  Why do Companies Issue Warrants and Convertibles?

23- 3 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved Warrant Value Example: BJ Services warrants, April 2000 Exercise price $ 15 Warrant Value $110 Share price $ 70 BJ Services share price 15 Warrant price at maturity

23- 4 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved Warrant Value vs. Stock Price Value of warrant Exercise price = $15 Actual warrant value prior to expiration Theoretical value (warrant lower limit) Stock price

23- 5 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved United Glue Warrants  # shares outstanding = 1 mil  Current stock price = $12  Number of shares issued per share outstanding =.10  Total number of warrants issued = 100,000  Exercise price of warrants = $10  Time to expiration of warrants = 4 years  Annualized standard deviation of stock daily returns =.40  Rate of return = 10 percent  United glue has just issued $2 million package of debt and warrants. Using the following data, calculate the warrant value.

23- 6 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved United Glue Warrants  United glue has just issued $2 million package of debt and warrants. Using the following data, calculate the warrant value.

23- 7 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved United Glue Warrants  United glue has just issued $2 million package of debt and warrants. Using the following data, calculate the warrant value. (d 1 ) = N(d 1 ) =.865 (d 2 ) =.304 N(d 2 ) =.620

23- 8 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved United Glue Warrants  United glue has just issued $2 million package of debt and warrants. Using the following data, calculate the warrant value. Warrant = 12[.865] - [.620]{10/1.1 4 ] = $6.15

23- 9 McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved United Glue Warrants  United glue has just issued $2 million package of debt and warrants. Using the following data, calculate the warrant value.  Value of warrant with dilution

McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved United Glue Warrants  United glue has just issued $2 million package of debt and warrants. Using the following data, calculate the warrant value.  Value of warrant with dilution

McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved United Glue Warrants  United glue has just issued $2 million package of debt and warrants. Using the following data, calculate the warrant value.  Value of warrant with dilution

McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved What is a Convertible Bond?  Amazon  4.75% Convertible 2009  Convertible into 6.41 shares  Conversion ratio 6.41  Conversion price = 1000/6.41 = $  Market price of shares = $120  Lower bound of value  Bond value  Conversion value = 6.41 x 120 = $768.00

McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved What is a Convertible Bond?  How bond value varies with firm value at maturity default bond repaid in full Bond value ($ thousands)

McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved What is a Convertible Bond?  How conversion value at maturity varies with firm value Conversion value ($ thousands)

McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved What is a Convertible Bond?  How value of convertible at maturity varies with firm value default bond repaid in full convert Value of convertible ($ thousands)