FIE402 CORPORATE FINANCE

Case: Crown Corporation

Fall 2014

Crown Corporation: external funding needs

Short term (1969) funding need of $ 30 mio

Large funding needs next several years
69
70
71
72
Sum

Capex
$ 39
32
7
50
$ 128

Ext. needs
$ 30
22
30
$ 82

Alternatives for 1969:

Common Stock
Term Loan 6yrs 7.25%
Convertible Debt 20yrs 6%

(1,4 m shares @ $21.50)

(repay $ 5 mio for 6 years)
(5 yrs grace; conv. $ 31.50)
2

Start up: 1966

Capacity: 278 000 ton/yr

Maryland

Start up: 1970

Capacity: 185 000 ton/yr

Crown Corporation 1968

External Funding Needs

profitability: projected profit statements

growth: cash flow needs
balance sheets or flow-of-fund analysis
understatement of likely funding needs ?
free cash flow risk

Business Risk

Impact of the 3 Alternatives

Final assessment

The Convertible Bond

Extra Slides

Net Income & Retained Earnings

(slide 35)

Sales growth: 7 % (Crowns expected growth 6-8%)

EBIT-margin: 12 % 1969-70 (start-up Intalco & DC-10);
14 % 1971-72 (economies Intalco, but start-up Eastalco)
No accounting for costs of new funding
Dividends: $ 0.70 per share (7.273 mio shares)

(millions of dollars)
Actual
1968
$230,0

1969
$246,0

EBIT (68: 28,5 + 2,4 / 69-70: 12%; 71-72: 14%

Interest (6%)
Net income before taxes
Income taxes (48%)
Net income after taxes
Dividends
Retained earnings

30,9
3,4
$27,5
13,8
$13,6
5,1
$8,5

29,5
3,2
$26,3
12,6
$13,7
5,1
$8,6

31,6
2,9
$28,7
13,8
$14,9
5,1
$9,8

39,5
2,6
$36,9
17,7
$19,2
5,1
$14,1

42,1
2,3
$39,8
19,1
$20,7
5,1
$15,6

Earnings per share

$1,87

$1,88

$2,05

$2,64

5
$2,85

Sales

(7% grow th)

Projected
1970
1971
$263,0
$282,0

1972
$301,0

Balance Sheet External Funds needed (slide 34)

(millions of dollars)

Cash & securities

Accounts receivable (18%
Inventory (22% of sales)
Other
Current assets
Net fixed assets
Other
Total assets

Actual
1968
$10
42
50
1
$103
82
4
$189

1969
$10
44
54
1
$109
113
4
$226

Projected
1970
1971
$10
$10
47
51
58
62
1
1
$116
$124
133
126
4
4
$253
$254

1972
$10
54
66
1
$132
162
4
$298

Accounts payable (6% of s

Accrued liabilities (4% of s
Accrued taxes
Dividends payable
Current portion - long-term
Current liabilities
Long-term debt
Deferred taxes
Equity
Liabilities & net worth

$14
10
6
1
4
$35
52
3
99
$189

$15
10
6
1
4
$36
48
4
108
$195

$16
11
7
1
4
$39
44
6
117
$206

$17
11
8
1
4
$41
40
7
131
$220

$18
12
9
1
4
$44
36
10
147
$237

Cum. external funds neede

Total liabilities & net w

$189

31
$226

47
$253

34
$254

60
$298

Annua l e xte rna l funds n

$ 31

$ 16

$ -13

$ 26

External funds needed from a Cash Flow Analysis

NI after taxes
Depreciation
Interest after tax
Cash from Operations
Working Capital:
(Incr)/Decr Current Assets
Incr/(Decr) Current Liabililitie
Deferred Taxes
Net from Operations
Capex
Free Cash Flow

Debt
Interest after tax
Free Cash Flow - Equity
Dividends
Equity issue/(rep)
(Incr)/Decr Cash
External Funds needed

Actual
1968
$14
5
2
$20

Projected
1970
1971
$15
$19
12
14
2
1
$28
$35

1969
$14
8
2
$23

-12
2
0
$10
-20
-$9

-6
1
1
$18
-39
-$20

-7
3
1
$25
-32
-$7

-8
3
0
$30
-7
$23

-8
3
2
$33
-50
-$17

-2
-2
-13
-5

-4
-2
-26
-5

-4
-2
-12
-5

-4
-1
17
-5

-4
-1
-22
-5

$31

$17

-$12

$27

1972
$21
14
1
$36

18
7

Understatement of expected Funding Needs ?

Funding costs: ignore costs of new funding

Sales growth (7%) and profit margin (12-14%):
ignore adverse company, industry, or economy
developments
Start-up costs: ignore potential problems with
production of DC-10 landing gear, and new plant
expansion

External funding need in 1970 may well be twice

the projected (expected) level of $17m (or $22m)

Crown Corporation 1968

External Funding Needs

Profitability
Growth / Understatement of likely funding needs ?
Risks
EBIT may well fall by 50% in any future year
high financial commitments w.r.t. Eastalco
but, 2nd stage ($ 50m in 72) can be delayed (?)
Business Risk
Industry
Company position
Commitments
9

Business Risk
Fabricated Aluminum

Precision Casting

Industry
standard products, highly
competitive, open entry
volatile & cyclical
demand, high fixed costs
capacity growth,
substitutes

Industry
specialized products,
entry barriers
but: one main buyer
(US gov.), no growth

Crowns position
small
large expansion

Crowns position
relatively strong
10

EPS - growth 1962 - 69 est

4

Avg. p.a.
growth
Crown
18%
Alcan
11
Alcoa
12
Braun
8
S&P Ind
7%

High growth

EPS growth 1962 - 69 est

Stdev
54%
18
25
29
7%

Crown

Alcoa
Alcan
Braun
S&P

0
1962

1963

1964

1965

1966

1967

1968

1969

EPS growth yearly - Crown vs Alcoa

125%

66

EPS-growthCROWN

100%
75%

Volatile growth
Corr : 0.9
Slope : 2.7
(= 0.9 54% / 25%)

65

50%
67

Slope 1.0
64

25%
0%
-25%

68

0%

69

25%

-25%
63

-50%
EPS-growth ALCOA

50%

Exh. 4 Comparative Data on Aluminum Companies

S&P 400
1968 sales (mio)
Growth EPS 63-69
P/B
P/E
ROE est 69
ke (6,0% + beta4%)
Debt / Enterprise Value
Beta (Alcoa = 1.20)

7%
18

1,0

Alcoa
$1 353
12 %
1,5
14
11,0 %
10,8 %
0,29
1,2

Alcan
$1 081
11 %
1,3
13
10,0 %
11,6 %
0,40
1,4

Braun
$850
8%
1,6
13
12,0 %
12,1 %
0,44
1,5

Crown
$230
18 %
2,3
16
14,2 %
10,2 %
0,18
1,0

Harvey
$177
6%
1,8
20
8,8 %
10,7 %
0,28
1,2

Aluminum Asset beta (Alcoa) = 1.2 (1 0.29) = 0.85

Equity betas = 0.85 / (1 D/EV)

12

Key Ratios Crown

Sales
Net income
Capital Employed
Equity
Market cap
Debt/Capital - book
- market
P/B
P/E
ROE
(Rf + beta4%)
ke
RF
beta (= 1,0 in 1969)
Dividend yield
Capital gain
Return - geom

1965
$141
4,7
$101
69
60
0,32
0,35
0,9
13

1966
$176
10,8
$110
80
134
0,27
0,18
1,7
12
14,5 %
9,1 %
4,0 %
5,0 %
1,0
2,2 %
118,5 %
120,7 %

1967
$213
14,8
$149
91
266
0,39
0,18
2,9
18
17,3 %
9,1 %
5,0 %
1,0
1,6 %
94,9 %
96,5 %

1968
$230
13,7
$155
99
302
0,36
0,16
3,0
22
14,4 %
10,0 %
6,0 %
1,0
1,7 %
12,6 %
14,3 %

Grwth
66 - 68
18 %
43 %
15 %
13 %
71 %
0,34
0,17
2,5
17
15,4 %
9,4 %

avg.
avg.
avg.
avg.

1,8 % avg.
70 % avg.
71 %

13

Crown Corporation 1968

Business Risk
External Funding Needs
Impact of the 3 Alternatives
Tax benefits

Agency costs

If constant debt: DTS = (0,48) $30m = $14,4

$ 2 per share ($14,4m / 7,3m)
highly volatile EBIT and tax position of Crown
Little information to judge

Accounting ratios and rating

14

Accounting ratios / debt rating

Exh. 8: Aluminum Companies 1968

1968 sales (mio)

L.T. debt / Tot. Cap
Times Int. earned
Rating - Senior Debt
- Conv. Sub. Debt

(EBIT+Int.Inc)/Int.Cost= 30.9 / 3.4

Alcoa
$1 353
39 %
6,6
A
BBB

Alcan
$1 081
46 %
5,2
A

Braun
$850
55 %
4,8

Crown
$230
34 %
9,2

Harvey
$177
41 %
6,7
BBB

Exh. 9: Crown pro forma Dec 31 1969

Ba nk Co nve rtib le Co mmo n
Lo a n
D e bt
S to ck

S tra ig ht d e b t
Co nve rtib le d e b t
E q uity
Interest cost
T ime s Inte re st E a rne d

43%
57%

27%
16%
57%

27%
73%

$5,4
5,5

$5,0
5,9

$3,2
9,2

Covenants

15

Accounting ratios: S & P average 94 -96 and norms

Investment grade
AAA
AA
A
BBB
21x
10x
5,7x
2,9x
23
28
37
45
110
75
49
30

Ratio
Interest coverage*
Debt / Capital (%)
Cash flow / Debt (%)

Speculative
BB
B
2,3x
0,7x
56
71
20
-2

Crown 69
Equity
Debt
9.2x
5.5x
27
43
72
46

* Times-Interest-Earned = (EBIT + financial income) / interest cost

TIE =
Quality
Outstanding
Above avg
Average
Below avg
Vulnerable

Outstanding
Above avg
Average
Below avg
Vulnerable

AAA
30
20

AA
A BBB
Debt / Capital (%):
40
50
60
25
40
50
30
40
25
35
25

Cash flow / Debt (% ):

80
60
40
25
150
80
50
30
105
60
35
85
40
65

BB
70
60
55
45
35

10
15
20
25
45

EBIT + Fin.inc.
Int.cost

27

Cflw/Debt =

72

43

EBITDA
Debt

46
16

How To Choose a Capital Structure

Shivdasani & Zenner; J. of Applied Corp Fin; 1/2005

Company size is dominant in comparing ratings

across industrials

Crown is a small player

17

Crown Corporation 1968

External Funding Needs

Business risk

Impact of the 3 Alternatives

Final assessment

flexibility

18

Final assessment

Considering the funding of 1969 in isolation, all three

alternatives are feasible, BUT

Straight debt

Common stock

rules out further straight debt in 1970

may also rule out convertible debt, if business worsens

highly flexible financial position for future years

allows straight debt funding in 1970

Convertible debt

more flexibility than a straight debt issue

however, may be stuck with a hung convertible issue
for an indefinite period.

19

The final decision will depend on

trade-off between cost and flexibility
and expectations of earnings and stock price over
next few years
Currently a relatively favorable P/E-ratio, but
earnings projections do not look promising for 1969
(Eastalco expansion and start-up costs on DC-10
landing gear)
Indicates a declining, rather than a rising stock price
for the next year, and
weakens the case for convertible (and straight) debt
for 1969
20

Stock price and P/E 1962 - 1969 Feb

Price growth mid 1962 - Feb 1969
600

500

400

Crown
Braun
Alcan
Alcoa
S&P

Growth
19.5%
3.0%
3.5%
3.5%
8.0%

Return
32%
5%
5%
5%
9%

Risk
55%
15%
16%
10%
8%

Crown

300

200

S&P
Alcoa

100

Braun

Alcan

0
1962

1963

1964

1965

1966

1967

1968

1969

Price/Earnings 1962 - 1969

24
22
20
18

18

S&P

16

16

Crown

14

Alcoa

14
Braun

12
10
1962

13

Alcan

1963

1964

1965

1966

1967

1968

1969

21

Crown Corporation 1968

External Funding Needs

Business risk

Impact of the 3 Alternatives

Final assessment

The Convertible

Why use a convertible ?

Pricing the Crown convertible

22

Why issue a Convertible ?

Instead of straight debt (sweetened debt)

lower coupon
(help cash flow, not expected costs)

get subordinated debt

(reduce agency costs: align interests of owners & creditors)

sell high risk

(idiosyncratic risk / risk insensitivity)

Instead of equity (delayed equity)

stock is cheap
(e.g. young growth firm)

backdoor equity: low debt capacity and high PVGO,

high uncertainty about stock value
reduce negative price reaction
(asymmetric information: delayed choice!)

23

CLAIM: Convertible debt is cheaper than regular debt, and

also allows us to sell shares at a higher than the current price!
18 %

Ex post cost

13 %

Ex post cost of funding

Convertible seldom the best alternative
ex post, but is a good compromise ex
ante when high risk

Common

Convertible

8%

Debt

3%

low

medium
Future value

high
24

Why issue Convertibles: Myth & Reality

Myth
Convertible debt is cheaper than regular debt, and
also allows us to sell shares at a higher than the
current price!
Reality:
The company keeps the banker when it really needs
an owner, but (gets) an owner when a banker had
been better!
Investor accepts a lower coupon as a lender, and a
higher (than todays) stock price as an owner.
25

Ex post cost of funding

Ex post cost

18 %

13 %

Convertible seldom the best alternative ex

post, but is a good compromise ex ante
when high risk

Common

Bond (Cp>>Rd)
Desired instrument !?
- Equity Put

Convertible

8%

Debt

Bond (Cp<<Rd)
+ Equity Call
3%

low

medium

high

Future value
26

Mandatory Convertible Debt

Forced conversion at fixed future date

P = Par bond value

Upper & lower
conversion price:
XU > XL
# shares: Ri=P/Xi
In between: X = ST
# shares: R = P/X

Call
-Put

27

Empirical facts

Convertibles used by
smaller companies
high P/B (PVGO)
low debt capacity (non-tangible assets)
high diversifiable risk

Stock price announcement effect:

straight equity:
- 3%
convertible debt: - 1.5%
(less if firm is known to have high PVGO)

straight debt:

0
28

Crown Corporation 1968

External Funding Needs

Business risk

Impact of the 3 Alternatives

Final assessment

The Convertible

Why use convertibles ?

Pricing the Crown convertible

29

Implicit Warrant value

Conversion price: X = $ 31.50

Conversion ratio: r = 100 / 31.50 = 3.175
{ ( 30m / 100) (3.175) = 952,500 shares }

Dilution: 7 273/(7 273 + 952.5) = 0.88 (ignored!)

Convertible = Straight Bond + rWarrant - BondCall

Bond: 78% ?

Bond call (year 10+): simplify, by truncating effective

length of warrants to 10 yrs (also redemption from yr 6)

(9% for 20 yrs subordinated)

Warrant: Implicit issue value =

6.9
( 22 / 3.175)

30

Pricing the Crown warrants

Convertible = 78.3 + 3.175 Call31.50

Assume smaller stock price reaction S0 = $ 25

Adjust stock price for future dividends:

Discrete dividends: $ .70 growing at 6% p.a.
PV[FT] = S0 PV[div] = $25 0.70T

Forward price: FT = PV[FT] (1.06)T

Ignores early exercise (low dividend, yield 2.8%)

Volatility : 30% (?)

31

Crown: .4 / .5 with T = 10 years

PV[F] = 25 - 7 = 18
F = 18 (1.06)10 = 32.2
T = 30%(10).5 = 95%

C31.5 = 0.4 95% 18 + .5 (+0.7)/(1.06)10

=
6.8
+
0.2
= 7.0
B&S = 6.7

Convertible = 78 + 3.175 6.7 = 99.3

32

Dividends growing at 6% from $0.70

30% Volatility
Maturity (T)
0
PV[F]
25
Forward (F)
25
30 %
VolaT
Call (B&S)
Convertible (B = 78.3)
0,4*volaT*PV[FV]
'ATMF'+ 0.5*PV(F-X)
1

PV[F] = 25 - 0,70*T

Forw ard = PV[F]*(1,06) T

5
21,5
28,8
67 %
5,0
94,2
5,8

10
18,0
32,2
95 %
6,7
99,6
6,8

15
14,5
34,8
116 %
6,8
99,9
6,7

20
11,0
35,3
134 %
5,8
96,7
5,9

4,7

7,0

7,4

6,5

33

Crown Corporation 1968

External Funding Needs

Business Risk

Impact of the 3 Alternatives

Final assessment

The Convertible Bond

Extra Slides

34

Extra

Assumptions

Working capital ratios as current (1968)

Sales growth
Profit margin (EBIT/Sa

1965
16 %
7%

1966
25 %
11 %

1967
21 %
14 %

1968
8%
13 %

1969
7%
12 %

Projected
1970
1971
7%
7%
12 %
14 %

Acc.rcvbls/Sales
Inventory/Sales
Acc pbls/Sales
Accr.liab./Sales

14
20
6
4

13
22
6
4

16
22
6
3

18
22
6
4

18
22
6
4

18
22
6
4

%
%
%
%

%
%
%
%

%
%
%
%

%
%
%
%

%
%
%
%

%
%
%
%

18
22
6
4

%
%
%
%

1972
7%
14 %

18
22
6
4

%
%
%
%

Net fixed assets:

Beg. yr
Capex
Dep

Actual
68
68
19
-5

69
82
39
-8

Proje cted
70
71
113
133
32
7
-12
-14

72
126
50
-14 Assumption
35

EPS for 1969 for alternative EBIT Levels

EBIT
$15,0
$25,0
$30,0
$35,0
ROCE (after 48% tax)
4,1 %
6,8 %
8,2 %
9,6 %
Bank Loan
Interest
$4,3
Taxes (48%)
5,1
9,9
12,3
14,7
Net income after taxes
$5,6
$10,8
$13,4
$16,0
Avg. number of shares
7,3
Avg. equity per share
$14,9
$15,2
$15,4
$15,6
EPS
$0,77
$1,48
$1,84
$2,19
ROE (avg. Equity)
5,1 %
9,9 %
12,3 %
14,7 %
Convertible Debt
Interest
$4,1
Taxes (48%)
5,2
10,0
12,4
14,8
Net income after taxes
$5,7
$10,9
$13,5
$16,1
Avg. number of shares
7,3
Avg. equity per share
$14,9
$15,2
$15,4
$15,6
EPS
$0,78
$1,49
$1,85
$2,21
ROE (avg. Equity)
5,2 %
10,0 %
12,4 %
14,8 %
Convertible Debt (Fully Diluted)
$3,2
Interest
5,7
10,5
12,9
15,3
Taxes (48%)
Net income after taxes
$6,1
$11,3
$13,9
$16,5
7,7
Avg. number of shares
$15,9
$16,2
$16,6
$16,4
Avg. equity per share
$0,79
$1,46
$1,80
$2,13
EPS
ROE (avg. Equity)
5,0 %
9,2 %
11,3 %
13,4 %
Common Stock
Interest
$3,2
Taxes (48%)
5,7
10,5
12,9
15,3
Net income after taxes
$6,1
$11,3
$13,9
$16,5
Avg. number of shares
8,0
Avg. equity per share
$15,4
$15,8
$16,1
$15,9
EPS
$0,77
$1,42
$1,75
$2,07
ROE (avg. Equity)
5,0 %
9,2 %
11,3 %
13,4 %
Note: Interest is $3.2 mio on old debt, $1.1 mio on term loan, and $1.8 mio on convertible.

Extra

EPS = Net income / n

n avg. number of shares
= 7.27 + new/2
nEq = 7.27 + 1.40/2 = 8.0m
nCD* = 7.27 + 0.95/2 = 7.7m
ROE = Net income / BPS
BPS Avg. equity per share
= Avg. equity / n
= [108 + (new+retain)/2] / n
BPSEq:
[108 + (30+NI-6.1)/2] / 8.0
BPSCD*:
[108 + (30+NI-5.8)/2] / 7.7
36

Extra

Comparative Data on Aluminum Companies

S&P 400
1968 sales (mio)
Growth EPS 63-69
P/B
P/E
ROE est 69
ke (6,0% + beta 4%)
Debt / Capital - market
Beta (Alcoa = 1.20)
Pay-out 69
Div. yield (68)
P-growth (63-68)
Return-Geom 63-68
ke (4,4% + beta4%)
EPS est. 69
Book per share
Feb 1969 price
Dividend / share 69

7%
18

1,0
0,51
2,9 %
9,1 %
11,9 %
8,4 %
$6,25
$113
$3,21

Alcoa
$1 353
12 %
1,5
14
11,0 %
10,8 %
0,29
1,2
0,33
2,4 %
3,9 %
6,3 %
9,2 %
$5,40
$49
$76
$1,80

Alcan
$1 081
11 %
1,3
13
10,0 %
11,7 %
0,40
1,4
0,48
3,7 %
1,3 %
5,0 %
10,1 %
$2,30
$23
$30
$1,10

Braun
$850
8%
1,6
13
12,0 %
12,8 %
0,44
1,7
0,33
2,6 %
6,7 %
9,3 %
11,2 %
$3,00
$25
$39
$1,00

Crow n
$230
18 %
2,3
16
14,2 %
10,2 %
0,18
1,0
0,38
2,4 %
33,9 %
36,3 %
8,6 %
$1,85
$13
$30
$0,70

Harvey
$177
6%
1,8
20
8,8 %
11,0 %
0,28
1,3
0,69
3,4 %
11,4 %
14,8 %
9,4 %
$1,75
$20
$35
$1,20
37

Extra

Key ratios Crown

Sales
Net income
Capital Employed
Equity
Market cap
Debt/Capital - book
- market
P/B
P/E
ROE
(Rf + beta4%)
ke
RF
beta (= 1,0 in 1969)
Dividend yield
Capital gain
Return - geom
EPS
Dividend per share
Payout ratio (div/eps)
Turnover ( Sales/Cap.Empl. )
Profit_margin ( Net income/Sales )
Shares outstanding (mio)
Book value per share
Mid-price

1965
$141
4,7
$101
69
60
0,32
0,35
0,9
13

1966
$176
10,8
$110
80
134
0,27
0,18
1,7
12
14,5 %
9,1 %
4,0 %
5,0 %
1,0
2,2 %
118,5 %
120,7 %
$1,50
0,40
0,27
1,7
6,1 %
$7,1
9,7
8,5

$7,2
11,0
18,5

1967
$213
14,8
$149
91
266
0,39
0,18
2,9
18
17,3 %
9,1 %
5,0 %
1,0
1,6 %
94,9 %
96,5 %
$2,03
0,60
0,30
1,6
6,9 %

1968
$230
13,7
$155
99
302
0,36
0,16
3,0
22
14,4 %
10,0 %
6,0 %
1,0
1,7 %
12,6 %
14,3 %
$1,87
0,70
0,37
1,5
6,0 %

$7,3
12,5
36,5

$7,3
13,6
41,5

1969
Grw th
debt equity
66 - 68
$246
18 % $246
12,5
13,7
43 %
$189
15 % $189
107
137
13 %
218
241
71 %
0,43
0,28
0,34
0,27
0,18
0,17
2,5
2,0
1,8
17
17,4
17,6
15,4 % 12,2 % 11,6 %
9,4 % 11,1 % 10,6 %
6,5 % 6,5 %
1,2
1,0
1,8 % 2,3 % 2,5 %
70 %
71 %
41 % $1,80 $1,58
45 %
0,70
0,70
0,39
0,44
0,31
1,4
1,6 1,4
6,3 % 5,1 % 5,6 %

12 %
70 %

$7,3
14,7
30,0

$8,7
15,8
27,8

38

Extra

20 yr non-callable, subordinated Bond (6% vs e.g. 9%)

t
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Sum

Loan
Payment
beg. yr Coup Amort
100,0
6,0
100,0
6,0
100,0
6,0
100,0
6,0
100,0
6,0
100,0
6,0
6,7
93,3
5,6
6,7
86,7
5,2
6,7
80,0
4,8
6,7
73,3
4,4
6,7
66,7
4,0
6,7
60,0
3,6
6,7
53,3
3,2
6,7
46,7
2,8
6,7
40,0
2,4
6,7
33,3
2,0
6,7
26,7
1,6
6,7
20,0
1,2
6,7
13,3
0,8
6,7
6,7
0,4
6,7
78
100

Total
6,0
6,0
6,0
6,0
6,0
12,7
12,3
11,9
11,5
11,1
10,7
10,3
9,9
9,5
9,1
8,7
8,3
7,9
7,5
7,1
178

PV
(y = 9%)
5,5
5,1
4,6
4,3
3,9
7,6
6,7
6,0
5,3
4,7
4,1
3,7
3,2
2,8
2,5
2,2
1,9
1,7
1,5
1,3
78,3

PVt
5,5
10,1
13,9
17,0
19,5
45,3
47,0
47,6
47,5
46,7
45,5
43,8
41,8
39,7
37,3
34,9
32,5
30,0
27,6
25,2
659

IF:
y = 6 % (= Cp ) P = 100.0
y = 9 % P = 78.3
y = 3 % P/P = - 21.7
P/P - MDur (y Cp)
MDur(y=6%) 7.0

Dur = 659 / 78.3 = 8.4 MDur(9%) = 8.4 / 1.09 =397.7

Pricing Crown warrants w/B & S: T = 10yrs

Spot
Funding
Dividend
Vol (p.a.)

25
6%
0,70
30 %

Maturity
Strike
Forward
Vol (T)

10
31,5
32,2 = (25 - 0,70*10)*(1,06
95 % = 30%*sqrt(10)

ln(F/X) =

2,3 % = ln(32.2 / 31.5)

d1 =

0,499 = (0,023 + 0,5*0,952) / 0,95

d2 =
n1 =
n2 =

-0,450 = 0,499 - 0,5*0,95

0,691
0,326

Call

6,7

Extra

Delta-value shares

12,4 = (25 - 0,70*10)*0,69

40

Extra

Problems in pricing warrants

american value ?

dilution effect (company issues new shares)

long-term volatility

41

Extra

American value

Conversion is typically allowed only at time of each

coupon payment for the bond (quasi-american),
and may be forced by sinking fund retirement or a
bond call
(companies tend to avoid calling a convertible, even
if warrants are deep-in-the-money)
Should use a binomial valuation if dividends are
large, and are paid close to (but after) the coupon
dates
Otherwise, use a a modified European call valution,
with current stock price (S) adjusted for discounted
dividends
42