PRICING OF WARRANTS AND THE VALUE OF THE FIRM

issues warrants. In order to focus on the potential dilution effect of warrants on the current value of the firm, we assume throughout the analysis that the investment policy of the firm is given and is not being affected by its financial decisions.3 Under this assumption and the assumption of perfect capital markets, the issuance of warrants will not affect the wealth of the current security holders of the firm. However, as will be demonstrated, it may increase the current market value of the firm's future cash inflow, an increase which is offset by the added liability of its securityholders in such a way as to leave their wealth unchanged. In Section II it is shown that in a framework of a one period model the value of a warrant is a fraction of the value of a call option issued on the same stock, ceteris paribus. In Section III we analyze within a one period model the value of the firm which issues warrants. In Section IV the implications of issuing warrants on the price of the firm's stock are discussed. In Section V we expand the analysis to the multi-period framework. It is shown that the results obtained for the one-period case are also valid, qualitatively, for the multi-period case. Section VI contains the summary and conclusions of the analysis. II. THE WARRANT AS A DILUTED CALL OPTION