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Redone Corporation is setting terms on a new issue of bonds with warrants through which they will raise $15 million of new capital. The bonds have $1000 par value, 20-year maturity, and annual coupon. Each bond will have 40 warrants attached, which give the holder the right to purchase one share of Redone stock per warrant at an exercise price of $17. The warrants have a life of 9 years. Redone’s investment banker estimates that equivalent call options (LEAPS) currently have a value of $5.20. Similar straight debt issues carry a yield of 13.031%. Redone’s stock currently sells at $16 per share, the firm is expected to pay a dividend of $1.632 at the end of the year, and the dividend is expected to grow at a constant growth rate of 3.8% forever thereafter. The firm has currently 1.3 million shares outstanding. The firm has a 40% marginal tax rate. The firm’s current capital structure is made of $25 million of straight debt and $30 million of equity.
a) What coupon rate should be set on the bonds so that the package would sell for $1000?
b) How much additional equity capital will the company get when the warrants are exercised?
c) Compute the yield to the investors from the package, if the package is sold at par.
d) Compute the cost to the firm from the package, if the package is sold at par.
e) Compute the WACC to the firm prior to and after raising the $15 million of capital.
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