A warrant is a long-term option from a company that gives the holder the right to buy a stated number of shares of the firm’s stock at a specified price for a specified length of time. Generally, warrants are distributed with debt, and they are used to induce investors to buy long-term debt that carries a lower coupon rate than would otherwise be required. The exercise of warrants brings in additional funds to the firm.
A corporation decides to issue 10-year bonds to fund a necessary expansion. If they were straight bonds, they would carry an 9% annual coupon. However, the bonds with warrants can be sold with a 7% coupon. Thus, investors would be paying $800 in return for the 7% coupon, 10-year bond and 23 warrants.
Suppose that the warrants expire in 5 years, and the exercise price on the warrants is $11. (Remember that each bond includes 23 warrants.) The firm’s current stock price is $9.50, but the price is expected to grow by 16% per year.
Assuming that the warrants will not be exercised prior to expiration, what is the overall rate of return to investors? Round your answer to two decimal places.
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