Question

1. Firms A and B have values as separate firms of 500 and 100, respectively, and both are all-equity firms. Firm A is going to buy firm B, and the merged firm will have a value of 700. Firm B is willing to sell to firm A for 150 in cash. Firm A has 25 shares before the merger and Firm B has 10 shares.

1. What is the NPV to firm A’s shareholders?

2. What cost would firm A’s shareholders see if this deal was paid for with stock and firm A exchanged 7.5 shares of new stock to buy firm B?

3. What exchange rate would make a stock deal the same cost to firm A’s shareholders, as the original cash deal?

Answer 1

a. NPV to firm A's shareholders = Benefit - Cost

The calculations will be as shown in following screenshot:

Part b)

Part c)

Thus the exchange rate of 0.696 shares of A for each share of B would make the cost same to shareholders of A.

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