Question

Company A has 10 million shares trading at a price of $9m, as investors view it should be $10 or $8 with equal probabilities. However, its management knows the true value per share is $10. The company is planning the acquisition of company T, which has 4 million shares trading at $15. Advisors tell company A it will have to pay a 20% premium for company T's shares over their current price. The acquisition would create synergies worth $15m. If the deal is to go through, company A will pay company T’s shareholders with new shares of company A.

As a benchmark, assume markets also know true value per share to be $10.

a. What will be A’s market capitalization after acquiring T? What fraction of its equity will be held by former T shareholders? What will be its value? What fraction of shares will A’s existing shareholders retain? What will be its value? What gains will A’s shareholders (as a group) and T’s shareholders (as a group) realize respectively in the acquisition?

Answer 1