Question

1. During 2017, Jalfar Inc. issued 10,000 stock warrants for cash in a public offering. Each warrant allows the holder to acquire one share of Jalfar common stock at $10 per share any time in the next five years. On 12/31/2017, Jalfar’s common stock price is $15 per share. From these facts,
   1. the fair value of each stock option is $5 at year-end
   2. the original issuance of the stock warrants reduced stockholders’ equity
   3. the intrinsic value of each warrant is $5 at year-end(answer)<---------------------- answer
   4. the exercise or strike price of the warrant is $15 per share at year-end
   5. none of the above

Can someone give me a detailed explanation of why the answer is C? the answer is already given but I just want an explanation so I can have a better understanding. I'd greatly appreciate it. Thanks in advance!

Answer 1

A warrant is a long-term security, issued by a company, which provides the holder with the right to buy a fixed number of company’s ordinary shares at a fixed price during a specified period of time. Warrants are usually issued in conjunction with a bond or a preferred stock. The primary purpose of a warrant is to increase the marketability of the new issue.

A warrant usually has no value when it is issued. But, it becomes valuable when the market price of company’s ordinary shares moves above the fixed price at which the investor has a right to buy the common stock. Thus, the market value of a warrant is based upon the market price of the ordinary shares and the exercise price.

Here question reveals that the "Jalfar’s common stock price is $15 per share". From these facts,

We have following:-

No of warrants= 10,000

Current Market price of common stock = 15 $

Exercise Price of each warrant= 10 $

No of equity shares per warrant = 1

Hence,

Intrinsic value = (P_s – P_c) × N

Where, P_s = Current market price of equity share

P_c = Exercise price of warrant

N = number of equity shares per warrant

Therefore,

Intrinsic value= (15-10) x 1 = 5 $