Ch 16.2 (Stock Warrants)

Question 1

Warrants

Answer 1

> Certificates entitling the holder to acquire shares of stock at a certain price within a stated period.

> Become common stock and usually have a dilutive effect (reduce earnings per share).

> The holder has to pay a certain amount of money to obtain the shares.

Question 2

Under what three situations does the issuance of warrants or options to buy additional shares normally arise?

Answer 2

1. When issuing different types of securities, such as bonds or preferred stock, companies often include warrants to make the security more attractive—by providing an “equity kicker.”
2. Upon the issuance of additional common stock, existing stockholders have a preemptive right to purchase common stock first. Companies may issue warrants to evidence that right.
3. Companies give warrants, often referred to as stock options, to executives and employees as a form of compensation.

Question 3

Stock warrants issued with other securities

Answer 3

> Warrants issued with other securities are basically long-term options to buy common stock at a fixed price.

> Life of warrants = 5, 10, or perpetual years

Question 4

Detachable Stock Warrant

Answer 4

> Company can offer a unit comprising one share of stock and one detachable warrant.

> Can be detached (separated) from the stock and traded as a separate security.

> A company should allocate the proceeds from the sale of debt with detachable stock warrants between the two securities.

Question 5

Two allocation methods for a detachable stock warrant

Answer 5

1. The proportional method.

2. The incremental method.

Question 6

Proportional method (Detachable Stock Warrant)

Answer 6

Allocates the proceeds using the proportion of the two(security & warrant) amounts, based on fair values.

Question 7

Incremental method (Detachable Stock Warrant)

Answer 7

> Instances where a company cannot determine the fair value of either the warrants or the bonds.

> The company uses the security for which it can determine the fair value. It allocates the remainder of the purchase price to the security for which it does not know the fair value.

Question 8

Rights to subscribe to additional shares (Stock Right)

Answer 8

If the directors of a corporation decide to issue new shares of stock, the old stockholders generally have the right (preemptive privilege) to purchase newly issued shares in proportion to their holdings.

Saves existing stockholders from suffering a dilution of voting rights without their consent. Also, it may allow them to purchase stock somewhat below its fair value. Unlike the warrants issued with other securities, the warrants issued for stock rights are of short duration.

Companies make only a memorandum entry when they issue rights to existing stockholders.

If holders exercise the stock rights, a cash payment of some type usually is involved. If the company receives cash equal to the par value, it makes an entry crediting Common Stock at par value. If the company receives cash in excess of par value, it credits Paid-in Capital in Excess of Par—Common Stock. If it receives cash less than par value, a debit to Paid-in Capital in Excess of Par—Common Stock is appropriate.