You answer the following question:
If the firm issued preferred stock or warrants would it include these in the calculation of its WACC?
Your answer:
The firm that issued preferred stock or warrants would only include preferred stock in the calculation of its WACC. Preferred stock has a fixed dividend paid every period forever, so a share of preferred stock is essentially a perpetuity. Therefore, the cost of preferred stock is the fixed dividend divided by the current price per share of the preferred stock. This means that the firm uses preferred stock in its capital structure and must be included in the calculation of its WACC. On the other hand, warrant is a corporate security that looks a lot like a call option. It gives the holder the right to buy shares of common stock directly from a company at a fixed price for a given time period. Thus, warrants don't contribute to a project evaluation, which is what the WACC is used for.
However, one of the student disagree and wants me to respond to the following
"lease rethink your position on warrants. If the warrants are exercised, they are an obligation of the firm. Therefore, when computing the WACC the firm should assume the warrants will exercised and therefore include them when calculating the WACC."
Please advise your comments.