Debt with Warrants

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Debt with Warrants
Like a convertible security, debt with warrants attached is issued with a feature that allows its holder to purchase a given number of shares at a certain price. Warrants act as a “sweetener” when attached to debt securities. It adds its marketability and lowers its required interest rate. Usually, the holders (of warrants) will not exercise their warrants until the market value of the security exceeds the exercise price because they can purchase the said security in a cheaper price in the market.

Actually, there is a price effectively paid for each warrant when warrants are attached to a security, like debt or equity. This implied price of warrant is simply computed as the difference between the price of the debt with warrants attached and the straight debt value. Dividing the implied price of all warrants by the number of warrants attached will result in the implied price of each warrant. It can also be noted that if the implied price is above the estimated market value, the price of the debt with warrants attached may signify a relatively too high price. Stated differently, if the implied price is below the estimated market value, the debt will be more attractive because of its cheaper price. This estimated market value is actually the theoretical warrant value. Essentially, the closer the warrant is to its expiration date, the more likely its market value will equal its theoretical value. Method and Application

When computing the present value (PV) of debt with warrants attached, its valuation or method is the same as with the treatment of the debt alone. It is necessary to determine the relevant cash flows of each period and then apply the PV techniques. The step involves adjusting the sum of the scheduled annual payments and maintenance costs after the tax deductions attributable to maintenance, depreciation and interest to find the after-tax cash outflows for each period. After having computed the after-tax cash outflows for each...
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