Abstract

This paper addresses two warrant valuation topics: dilution and down-round price protection. I start with dilution because there is lingering confusion among appraisers on this subject. I address down-round price protection because the SEC has highlighted this issue, noting that a simple Black-Scholes-Merton (BSM) equation may not accurately value the warrants when there is down-round protection, that is, where the exercise price on the warrants will be lowered to match the price of any new financing at a lower price. I illustrate two alternative valuation methods: One combines a lattice and the BSM equation, and the other employs Monte Carlo simulation. With respect to dilution, I show that it is not an important concern in valuing warrants as long as you use common stock volatility when using a simple BSM equation and equity volatility when using the BSM equation modified for warrants. With respect to down-round protection, I illustrate the magnitude of the effects on the protection, which are facts specific.