Chrysler’s Warrants

Matt-Harsha-Strong; Murtaza Amil; Vilay Wadhwa; Jayant Das, Mihir Korke; Ravi Prakash

1. Value the Chrysler warrants held by the government on the following five dates: a) September 14, 1979: $5.016b) January 7, 1980 : $5.748c) April 8, 1980: $4.070 d) May 12, 1980: $6.256e) September 1, 1983: $23.442

Table 1

2. Why did the warrants’ value change over this time?

Chrysler’s warrant value has changed over time primarily because of changes in the stock price. Other factors are changes in the estimate of volatility, risk free rate and time remaining on the warrant.

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

300,000,000

350,000,000

400,000,000

450,000,000

9/14/1979 1/7/1980 4/8/1980 5/12/1980 9/1/1983

Total warrant value-Historic

Total warrant value-Implied

3. Value the government’s loan guarantee as of May 12, 1980. Remember that it amounts to a put option, which allows the banks to put their risky Chrysler loans to the government. Use the date in Exhibit 11 to estimate the volatility of returns on Chrysler debt.

We calculate the value of loan guarantees using 2 methods. 1) Treating the guarantee as a put option and 2) estimating the present value of interest savings Chrysler is getting from the guarantee. We get estimate of $372.5MM from method 1 and estimate of $360.3MM from method 2.

Table 2 (Method 1 – Put Option)

Alternate approach comparing the above “total put value” to the interest savings from a lower debt cost due to the government guarantee, discounted at Chrysler’s market debt rate:

Table 3 (Method 2 – Interest Savings)

4. What is the prospective internal rate of return to the government on the loan guarantee as of May 12, 1980, taking into account the expected fees and current value of the warrants?

E

We calculate the ex-ante IRR to be -15%.

Explanation: Value of Guarantee: $372.5 MM – refer Table 2 Value of Warrant on May 12, 1980 = $90.1MM refer Table 1 Fee: 1% of outstanding principal, assuming 10% prepayment risk and 10 year maturity.

5. How does this IRR compare with Chrysler-type risk priced in the open market?

Market rate for Chrysler-type risk is in the +20% range. Government IRR is -15%! Government is massively subsidizing Chrysler.

6. What price should Chrysler bid for its warrants in September 1983?

Shearson/Amex offered $20.1. We estimate value of call option in Sep 1983 to be $23.44. A price point b/w these 2 numbers make sense – say, $21.5. Total bid = $21.5*14.4MM = $309.6MM.

7. Based on your bid price, what was the IRR on the government’s liability after the fact?

“After the fact” IRR = -3%

Ex-Post  Cost of Guarantee 372525983      Value of Warrant 0 0 0 309600000

Fee  

11,000,000

11,000,000

11,000,000

Net CF -372525983 11000000 11000000 320600000IRR -3%      

8. Was government guarantee overpriced?

No, it was massively under-priced.

Pricing needs to be based on ex-ante estimates.

On the ex-ante basis, value to Chrysler = PV of Guarantee = ~$372MM. Cost to Chrysler = PV_Fee + PV_Warrant on May 12, 1980 = $44+$90.08 = ~$134MM. Government guarantee was under-priced by ~$240MM

Even ex-post, when warrants became much more valuable, pay-off to Government was lower than the value of guarantee by ~$30MM

Iacocca argument is not sound. Chrysler actually got a good deal, even based on ex-post analysis. While Government did not get the full price from Chrysler commensurate with the benefit Chrysler got from this deal, Government guarantee can still be justified based on positive externalities (such as saved jobs, tax revenue impacts, impacts on suppliers etc.) because the guarantee enabled Chrysler to continue as a going concern.