Question

ABC has 1 million shares​ outstanding, each of which has a price of $ 20. It has made a takeover offer of XYZ Corporation which has 1million shares​ outstanding, and a price per share of

$ 2.43. Assume that the takeover will occur with certainty and all market participants know this.​ Furthermore, there are no synergies to merging the two firms.

a. Assume ABC made a cash offer to purchase XYZ for $ 4.80million. What happens to the price of ABC and XYZ on the​ announcement? What premium over the current market price does this offer​ represent?

b. Assume ABC makes a stock offer with an exchange ratio of 0.24. What happens to the price of ABC and XYZ this​ time? What premium over the current market price does this offer​ represent?

c. At current market​ prices, both offers are offers to purchase XYZ for $ 4.80 million. Does that mean that your answers to parts ​(a​) and ​(b​) must be​ identical? Explain.

Answer 1

a) Premium = Purchase price - price of XYZ

= 4.8 - 2.43

= 97.53%

Price of ABC = Price of ABC - ( Premium * Price of XYZ)

= 20 - ( 2.43 * 97.53%)

= 20 - 2.37

= $ 17.63

b) Price of ABC = ( Price of XYZ + Price of ABC)/ ( 1+ Exchange ratio)

= 20 + 2.43 / 1.24

= $ 18.09

Price of XYZ = Exchange ratio * price of ABC

= 0.24 * 18.09

= 4.3416

Premium = Price of XYZ / price of ABC

= 4.3416/2.43

= 17.87%

c) No, premium for the offer in second part is lower because market price changes due to giving of shares of abc co. Hence stock of xyz will go up which results in lower premium.