Warrants and the Balance Sheet
Here is an annotated example of how warrants are priced and their effect on the balance
sheet. (I did this example in class).
A company has 10,000 shares outstanding with a market value of assets of $1,880,000.
The market value of debt is $400,000. The company issued 200 warrants some time ago.
The warrants are about to expire. Each warrant gives the owner the right to purchase 20
shares of the company at a subscription price of $120.
The value of a share is always just the (market) value of the equity divided by the number
of shares outstanding. In this problem, we don’t have the market value of equity, but we
DO have the market value of assets and the market value of debt, so we can just subtract
one from the other and we will have the market value of equity. (Remember that the
Balance Sheet Identity from your accounting courses says that Assets = Debt + Equity)
So, MVE = $1,880,000 - $400,000 = $1,480,000
Then the price (ignoring the warrants) is simply $1,440,000/ 10,000 shares = $148.
But the firm issues 200 of these warrants that allow holders to buy 20 shares for $120
each. These are treated just like rights. The price of a share after the warrants are issued
[(10,000 x $148) + (4,000 x $120)]/(10,000 + 4,000) = $140
The warrants seem to have dropped the value of the shares from $148 to $140. So where
did the $8 go? Well, that is the cost of issuing $120 shares when they should be worth
If you wanted to buy one of these warrants, how much would you pay? The warrants
allow you to get 20 shares @$120. Right now the shares are $140, so the warrants must
be priced high enough to not allow arbitrage. So 20 shares @$120 + warrants = 20 shares
@$140. The warrants are worth $400.
As an aside, lets assume the warrants could be bought for $350. This price
introduces an arbitrage. Here is how you would exploit it.
• Buy 1 warrant for $350. -$350
• Deliver the warrant and $2,400 (20 x $120) and receive 20 shares
• Sell the 20 shares in the market for $140 each. +
$2,800 • Put the $50 profit in your pocket PROFIT=