Question

Consider the following premerger information about a bidding firm (Firm B) and a target firm (Firm T). Assume that both firms have no debt outstanding.

	Firm B			Firm T
Shares outstanding		5,400			1,300
Price per share	$	53		$	23

  
Firm B has estimated that the value of the synergistic benefits from acquiring Firm T is $7,900. Firm T can be acquired for $25 per share in cash or by exchange of stock wherein B offers one of its shares for every two of T's shares.

Are the shareholders of Firm T better off with the cash offer or the stock offer?

• Share offer is better

• Cash offer is better

At what exchange ratio of B shares to T shares would the shareholders in T be indifferent between the two offers? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Exchange ratio              to 1  

Answer 1

Answer:-

Part 1:-

Cash received per share = $25

Value of stock = ($53 / 2) = $26.5

The stock value is higher and thus firm T would prefer stock offer. So, Share offer is better.

Part 2:-

Calculation of exchange ratio which would make the shareholder's indifferent between the two options:-

Let exchange ratio be X

Total shares of new firm = 5400 + (1300X)

Value of firm after merger = (5400 x 53) + (1300 x 23) + 7900

= $324000

So,

Price of share after merger (P) = $324000 / [5400 + (1300X)]

The value for shareholders under both option should be equal:-

1300 PX = 1300 x 25

P = 25/X

As, Price of share after merger (P) = 324000 / [5400 + (1300X)] and Price of share after merger (P) =25/X. So, equating both.

25/X = 324000 / [5400 + (1300X)]

324000 X = 135000 + 32500X

291500 X = 135000

So, X = 0.4631

Exchange ratio is 0.4631 to 1