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Warrants and the Balance Sheet.doc

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Administrative Studies
ADMS 2610
Rebecca Jubis

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 is: [(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 $148! 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 -$2,400 • Sell the 20 shares in the market for $140 each. + $2,800 • Put the $50 profit in your pocket PROFIT= $50 • Repeat So th
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