The current stock price of Mesa Industries, Inc. is $20 per share. The company wants to sell 20-year, annual coupon, $1000 par value bonds. Each bond will have attached 50 warrants; each warrant is exercisable into 1 share of stock at an exercise price of $25. The firm’s 20- year straight bonds yield 12%. Each warrant has a life of 10 years, and a current market value of $3. The warrants are expected to be exercised in Year 10, when the stock price is expected to be $36.50. Mesa Industries, Inc. has a marginal tax rate of 34%.
a) Compute the coupon rate that Mesa must set on the bonds with warrants, if it wants to sell the bonds plus warrants package at par.
b) Compute the before-tax yield to investors from the bonds + warrant, when it is sold at par.
c) Compute the after-tax cost to Mesa from the bonds + warrants, when it is sold at par.