Question 1) The treasurer of Riley Coal Company is asked to compute the cost of fixed income securities for her coroporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the following facts, is she correct?
Debt can be issued at a yield of 10.6 percent, and the corporate tax rate is 35 percent. Preferred stock will be priced at $50, and pay a dividend of $4.40. The floatation cost on the preferred stock is $2.
Question 2) Assume you can buy a warrant for $5 that gives you the option to buy one share of common stock at $15 per share. The stock is currently selling at $18 per share.
a) What is the intrinsic value of the warrant?
b) What is the speculative premium of the warrant?
c) If the stock rises to $27 per share and the warrant sells at its theoretical value without a premium, what will be the percentage increase in the stock price and the warrant price if you bought the stock and the warrant at the prices stated above.