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Given the following information answer the next two questions. Both firms are 100% equity. If acquired,...

Given the following information answer the next two questions. Both firms are 100% equity. If acquired, then this acquisition will result in yearly after tax profits of $250,000 in perpetuity. The required rate of return is 5%. Firm A can acquire Firm B for $82,500 in either cash or stock. Firm A Firm B Number of Shares 10,000 7,500 Price per Share $25.00 $10.00 What is the value of Firm B to Firm A? What is the merger premium over B's stock price?

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Answer #1

Total Value of Merged Company = Yearly After Tax Profit / Required Rate

Total Value of Merged Company = $250000 / 5%

Total Value of Merged Company = $5000000

2. Value of Firm B to Firm A = Total Value of Merged Company - Value of Firm A

Value of Firm B to Firm A = $5000000 - 10000 * 25

Value of Firm B to Firm A = $4750000

3. Merger Premium over B' Stock price = [(Acquisition Cost - Value of Firm B) / Value of Firm B]

Merger Premium over B' Stock price = [(82500 - 7500*10) / 75000]

Merger Premium over B' Stock price = 10%

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