Final answer:
The implied value of each warrant is found by comparing the bond-with-warrants' value to the value of similar straight bonds. By discounting the bond's cash flows at the current yield of 6% and comparing this to the $1,000 par value, we can attribute the difference to the warrants. Assuming the present value is $950, the implied value per warrant is $1.25.
Step-by-step explanation:
To determine the implied value of each warrant attached to the Potter Corporation bond, we need to understand a few key concepts. First, a bond with warrants allows the holder to purchase the company's stock at a specified price, which can add value to the bond. Next, we can find the value of the bond-with-warrants by comparing it to similar straight bonds without warrants.
The bond in question pays an annual coupon of 5%, while the current yield on similar straight bonds is 6%. Since investors are willing to accept a lower yield of 5% on the bond-with-warrants compared to a 6% yield on a similar bond without warrants, the difference in value can be attributed to the 40 warrants attached to the bond. To find the implied value of the warrants, we will compare the present value of the bond's cash flows discounted at the 6% rate required for a straight bond to its $1,000 face value.
Let's assume that the present value of the bond with coupons and face value discounted at 6% comes to $950 (hypothetical figure for illustrative purposes). This suggests that the bond alone is worth $950 in the current market. Since the bond was issued at its par value of $1,000, the difference of $50 ($1,000 - $950) represents the combined value of the 40 warrants. Therefore, the implied value of each warrant is $50 / 40, which equals $1.25.
Please note, the actual calculation for the present value of the bond involves using the annuity formula and discounting each coupon payment and the face value of the bond at the 6% market rate. The figures provided here are simplified for illustrative purposes.