1. Learning Objectives
Calculate the conversion value of a convertible security. (LO5)
Describe warrants and compare them to convertible securities. (LO6)
Calculate the intrinsic value and the speculative premium on a warrant. (LO7)
Show how convertible securities and warrants affect earnings per share as reported on the income statement. (LO8)

2. Valuation of Warrants Intrinsic value of a warrant: I = (M – E) x N
LO7
Valuation of Warrants
Intrinsic value of a warrant: I = (M – E) x N
Where
I = intrinsic value of a warrant
M = market value of common stock
E = Exercise price (or strike price) of a warrant
N = Number of shares each warrant entitles the holder to purchase
The speculative premium: S = W – I
S = Speculative premium
W = Warrant price
I = Intrinsic value

3. Figure 19-5 Market price relationships for a warrant
LO7
Figure 19-5 Market price relationships for a warrant
Value of warrant ($) 40 30
Market value
of warrant 20
Intrinsic value
of warrant
Speculative
premium 10
-10
Price of common stock
-20

4. Table 19-3 Leverage in valuing warrants
LO7
Table 19-3 Leverage in valuing warrants
Low Stock Price High Stock Price
Stock price, $25; warrant price, Stock price, $50; warrant price,
$5* +$10 movement in stock price $30 + $10 movement in stock price
New warrant price, $15 ($10 gain) New warrant price, $40 ($10 gain)
Percentage gain $ Percentage gain $10
in warrant $ in warrant $30
*The warrant price would be greater than $5 because of the speculative premium. Nevertheless, we use $5 for ease of computation.
= x 100 = 200%
= x 100 = 33%

5. Use of Warrants in Corporate Finance
LO7
Use of Warrants in Corporate Finance
May make a debt or preferred share issue more attractive
May be included as an add-on in a merger or acquisition agreement
Can be issued in a corporate reorganization or bankruptcy to offer shareholders a chance to recover some of their investment
Traditionally has been associated with speculative real estate companies, airlines, and conglomerates
Popular with young companies, companies in financial difficulties, chartered banks