Storm Software wants to issue $100 million in new capital to fund new opportunities. If Storm raised the $100 million of new capital in a straight-debt 20-year bond offering, Storm would have to offer an annual coupon rate of 12%. However, Storm’s advisers have suggested a 20-year bond offering with warrants. According to the advisers, Storm could issue 9% annual coupon-bearing debt with 20 warrants per $1,000 face value bond. Storm has 10 million shares of stock outstanding at a current price of $25. The warrants can be exercised in 10 years (on December 31, 2018) at an exercise price of $30. Each warrant entitles its holder to buy one share of Storm Software stock. After issuing the bonds with warrants, Storm’s operations and investments are expected to grow at a constant rate of 11.4% per year.
a. If investors pay $1,000 for each bond, what is the value of each warrant attached to the bond issue?
b. What is the component cost of these bonds with warrants? What premium is associated with the warrants?