Consider the following premerger information about a bidding firm (Firm B) and a

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. Shares outstanding Price per share Firm B Firm T 5,000 1,600 51 20 Firm B has estimated that the value of the synergistic benefits from acquiring Firm T is $9.200. Firm T can be acquired for $22 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? O Cash offer is better Share 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 to1

Explanation / Answer

In case of cash offer the Firm T shareholders receive total of (22*1600) = $35200. But if they opt for share exchange offer they receive 1 Firm B share for every 2 in Firm T. This will result in Firm B shareholding to increase to 5800 and the value of new firm will = (5000*51 + 1600*20 + 9200) = 319000 or per share value of (319000/5800) = 55. At 55 the value of Firm T shareholders 800 shares in Firm B will be = (800*55) = 44000. Hence they are better off with share offer.

For Firm T shareholders to be indifferent, the value of share offer should also be 35200. Let us denote the indifferent level shares to be x, then we have:

[319000/(5000 + x)] * x = 35200 ; re-arranging and solving for x, we get x = 620.1550 which means (1600/620.15) = 0.3876 shares of Firm B for each Firm T share

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