CHAPTER

29

Mergers and Acquisitions

Takeovers
Takeover is a general and imprecise term referring to the transfer of control of a firm from one group of shareholders to another group. As such, takeover occurs whenever one group of shareholders takes control from another. Takeovers can be friendly or hostile. Takeovers may occur in three different ways viz. acquisitions, proxy contests, and going-private transactions. Therefore, takeovers encompass a broader set of activities and can be depicted graphically as follows:

Varieties of Takeovers
Merger or Consolidation Acquisition Acquisition of Stock Acquisition of Assets

Takeovers

Proxy Contest Going Private (LBO)

Takeovers
Proxy Contests: It happens when a group of shareholders attempts to gain controlling seats on the board of directors by voting in new directors. A proxy is the right to cast someone elses votes. In a proxy contests, proxies are solicited by an unhappy group of shareholders from the rest of the shareholders.

Going-private Transactions: Under this form of takeover all of the equity shares are purchased by a small group of investors. Usually, the group includes members of current management and some outside investors. As a large sum of money needed to but stocks, funds are borrowed. This type of transaction is also known as leveraged buyouts. When existing management is highly involved in such types of transactions, it is also termed as management buyouts. The shares of the company are delisted from stock exchanges and no longer traded in the open market.

Acquisitions
There are three basic legal procedures that one firm can use to acquire another firm:
Merger or Consolidation Acquisition of Stock Acquisition of Assets

Acquisitions
Merger or Consolidation Merger refers to the complete absorption of one firm by another. The acquiring firm also known as bidder or bidding firm retains the name and its identity. It acquires all the assets as well as liabilities of the acquired firm also known as target firm. After the completion of merger, the acquired or target firm ceases to exist as a separate business entity. In case of consolidation, an entirely new firm is created. Under consolidation, both the acquiring and the acquired firms terminate their previous legal existence and become part of the new firm.

Acquisitions
Merger or Consolidation The rules for mergers and consolidations are basically the same. Acquisitions by merger and consolidation result in combinations of the assets and liabilities of acquired and acquiring firms. Example: Firm A acquires firm B in a merger. In the process of merger, firm Bs stockholders receive one share of firm A in exchange of two shares of firm B. From legal point, firm As stockholders are not directly affected by the merger. However, firm Bs shares cease to exist. On the other hand, in case of consolidation, the stockholders of firm A&B would exchange their shares for the shares of

Acquisitions
Merger or Consolidation a new firm (e.g. firm C). As the differences between merger and consolidation are not so important, the both types of reorganizations are termed as merger. Advantages:
simplicity (buyer assumes all assets and liabilities); no minority interests.

Disadvantages:
two-thirds of shareholders of both firms must approve; difficulty in obtaining co-operation of target companys management.

Acquisitions
Acquisition of Stock
A second way to acquire another firm is to simply purchase the firms voting stock in exchange for cash, shares of stock, or other securities. This process often starts as a private offer from the management of one firm to another. At some point of time the offer is taken directly to the shareholders of the target firm. This can be accomplished by a tender offer i.e. a public offer to buy shares. It is made by one firm directly to the shareholders of the other firm. If the offer is accepted then the shareholders of the target firm exchange their shares for cash or securities or both. The tender offer is frequently contingent on the bidding firms obtaining desired percentage of the total

Acquisitions
Acquisition of Stock
voting shares. If not enough shares are tendered, then the offer might be withdrawn or reformulated. The tender offer is communicated to the shareholders of the target firm by public announcement such as news paper advertisements. Sometimes general mailing is used in tender offer.

Choosing between an Acquisition by Stock and a Merger The following factors should be considered: In acquisition by stock, no shareholder meetings and votes are required.

Acquisitions
Acquisition of Stock
Choosing between an Acquisition by Stock and a Merger In acquisition by stock, the bidding firm can deal directly with the shareholders of the target firm. The target firms management and board of directors can be bypassed. Acquisition by stock is occasionally unfriendly, which makes the cost of acquisition by stock higher than the cost of a merger. Frequently, a significant minority of shareholder turns down the tender offer. If this happens, the target firm can not be absorbed completely and benefits are not realized.

Acquisitions
Acquisition of Stock
Choosing between an Acquisition by Stock and a Merger Complete absorption of one firm by another requires a merger. Many acquisition by stock end up in a merger later.

Acquisitions
Acquisition of Assets
A firm can effectively acquire another firm by buying most or all of the assets. In this case, however, the target firm not necessarily ceases to exist. Its assets are just sold off. Its shell may exist unless its shareholders decide to dissolve it. This type of acquisition requires a formal vote of the shareholders of the target firm. One advantage is that there is no minority shareholder problem. However, the acquisition of assets may involve transferring titles to individual assets. The legal process of such transfer may be costly.

Acquisition Classifications
There are three types of acquisitions
Horizontal acquisition takes place between two firms in the same line of business i.e. under same industry. The firms compete with each other in the product market. Vertical acquisition it involves firms at different steps of the production process. The bidder expands backwards towards the source of raw materials or forwards in the direction of the ultimate consumer. Conglomerate acquisition involves companies in unrelated lines of business. For example, acquisition of food product firm by an auto manufacturing firm.

29.2 The Tax Forms of Acquisitions

If one firm acquires another firm, the transaction may be taxable or tax free. Taxable Acquisition: If the bidding firm offers cash to the target firm for its equity, it will be treated as taxable acquisition. Under this type of acquisition, the shareholders of the target firm are considered to have sold their shares and there will be either capital gain or loss which is subject to tax.

29.2 The Tax Forms of Acquisitions

Tax-Free Acquisition: In this case, the acquisition is considered to be an exchange of shares of equal value instead of a sale with no capital gain or loss. The shareholders of the target firm must retain an equity interest in the bidding firm.

29.2 The Tax Forms of Acquisitions

Taxable versus Tax-Free Acquisition
There are two factors that should be considered when comparing a tax-free and a taxable acquisition viz. capital gain effect and write-up effect. The capital gain effect states that the shareholders of the target firm may have to pay capital gain taxes in a taxable acquisition and may demand higher price as compensation and thereby increase the cost of the merger. In a taxable acquisition the assets of the target firm are revalued or written up from their historic book value to the current market value. This is known as write-up effect. This effect results in higher depreciation expense for the target firm and desirable effect of reducing taxes.

29.3 Accounting for Acquisitions

When one firm acquires another firm, the bidder must decide whether the acquisition should be treated as a purchase or a pooling of interests.

The Purchase Method

This method requires that the assets of the target firm be reported at their fair market value on the books of the bidding firm. Under this method, an asset goodwill is created for accounting purposes. It is the difference between the purchase price and the estimated fair market value of the net assets i.e. assets less liabilities.

29.3 Accounting for Acquisitions

The Purchase Method
Firm A acquires firm B and pays 18m in cash by borrowing. The net fixed assets of Firm B i.e. 8m are appraised to 14m as fair market value. The total balance sheet assets are 16m. The firm A pays excess 2m of the fair market value, which is considered to be the goodwill.
Working capital Fixed assets Total Firm A 4 Equity 16 20 Total Firm AB 6 Equity 30 Debt 2 38 Total 20 20 Working capital Fixed assets Total Firm B 2 Equity 8 10 Total 10 10

Working capital Fixed assets Goodwill Total

20 18 38

29.3 Accounting for Acquisitions

Pooling of Interest
Under this method the balance sheets of the bidder and the target firm are pooled i.e. just added together. This is shown in the following table in reference to the previous example: Firm A Firm B Working capital 4 Equity 20 Working capital 2 Equity 10 Fixed assets 16 Fixed assets 8 Total 20 Total 20 Total 10 Total 10
Firm AB 6 Equity 24 30 Total

Working capital Fixed assets Total

30 30

29.3 Accounting for Acquisitions

Purchase vs. Pooling of Interests
One important difference between the purchase and pooling of interests accounting is goodwill. A firm may prefer pooling as it does not involve goodwill. The problem with goodwill is that the original amount must be amortized over a long period of time. The goodwill amortization expense must be deducted from reported net income although it is a non-cash deduction. However, unlike depreciation expense it is not tax deductible. As a result, the reported income under purchase accounting will be lower than that under pooling of interests accounting. Moreover, the purchase accounting may result in larger book value for total assets because of write-up of asset values. The combination of the above two will have

29.3 Accounting for Acquisitions

Purchase vs. Pooling of Interests
an unfavorable impact on accounting-based performance measure such as ROA and ROE.
Although, purchase accounting itself does not affect taxes, however, this method is typically used in taxable acquisitions. As the amount of tax deductible expense is not directly affected by the either of the accounting methods, cash flows are not affected and the NPV of the acquisition should be the same under either of the methods. Finally, there is no evidence that suggests that one method will create more value for the acquiring firm than the other.

29.3 Accounting for Acquisitions

Purchase vs. Pooling of Interests
However, pooling of interest is generally used when the acquiring firm issues voting stock in exchange for at least 90 percent of the outstanding voting stock of the acquired firm.

29.4 Determining the Synergy from an Acquisition

Gains From Acquisition
The incremental cash flow for evaluating a merger is the difference between the cash flow of the combined firm and the sum of the cash flows for the two firms considered separately. CF = EBIT + depreciation tax capital requirement

= Revenue - Cost - Tax - Capital requirements

29.4 Determining the Synergy from an Acquisition

Synergy
Suppose firm A is contemplating acquiring firm B. The synergy from the acquisition is Synergy = VAB (VA + VB) The synergy of an acquisition can be determined from the usual discounted cash flow model: T CFt Synergy = (1 + r)t

S
t=1

where
CFt = Revt Costst Taxest Capital Requirementst

29.5 Source of Synergy from Acquisitions

The different types of incremental cash flows indicate that the possible sources of synergy can be grouped into four basic categories: revenue enhancement, cost reduction, lower taxes and lower cost of capital.

Revenue Enhancement
One important reason for acquisitions is that a combined firm may generate greater revenues than two separate firms. Increased revenues may come from marketing gains, strategic benefits and market power.

29.5 Source of Synergy from Acquisitions

Marketing Gains It is frequently claimed that merger and acquisitions can produce greater operating revenues from improved marketing. Improvements can be made in the following areas: previously ineffective media programming and advertising effects a weak existing distribution network an unbalanced product mix

29.5 Source of Synergy from Acquisitions

Strategic Benefits Some acquisitions promise a strategic advantage. This is an opportunity to take advantage of the competitive environment if certain situations occur. A strategic benefit is more like an option. For example, benefit of advanced technology, managerial expertise, etc. Market or Monopoly Power One firm may acquire another to reduce competition. If this can be done, monopoly profits are obtained by manipulating prices. If society is affected, may be questioned by the authority.

29.5 Source of Synergy from Acquisitions

Cost Reduction
One of the most basic reasons for merger is that a combined firm may operate more efficiently than two separate firms. A firm can obtain greater operating efficiency in several different ways through a merger or an acquisition as follows:

Economies of Scale: Figure 29.2 Page 804

The average cost of production falls while the level of output increases. Spreading overhead refers to the sharing of central facilities.

Economies of Vertical Integration:

Operating economies can be gained from vertical as well as

29.5 Source of Synergy from Acquisitions

Economies of Vertical Integration: horizontal combinations. The main objective of vertical acquisitions is to make coordination of closely related operating activities easier. Technology transfers are another reason for vertical integration. Complementary Resources Some firms acquire others to make better use of existing resources or to provide the missing ingredient for success. Such as even sales throughout the year, better use of store capacity etc.

29.5 Source of Synergy from Acquisitions

Elimination of Inefficient Management: There are firms whose value can be increased with a change in management. Sometimes, the current managers fail to understand the changing business environment. They are sometimes reluctant to abandon the strategies and principles which they formulated working hard over the years. Mergers and acquisitions can be viewed as part of the labor market for top management.

29.5 Source of Synergy from Acquisitions

Tax Gains
It is one of the powerful incentives for some acquisitions. The possible tax gains that can come from an acquisition are as follows: the use of tax losses from net operating losses the use of annual debt capacity the use of surplus funds Net Operating Losses Sometimes firms have tax losses they cannot take advantage of. Tax losses are referred to as NOL i.e. net operating losses. The following example explains this further:

29.5 Source of Synergy from Acquisitions

The table shows the pretax income, tax, and after tax income for firms A and B. Firm A will earn $200 under state I but will lose money under state II. Conversely, firm B will pay taxes of $68 under state II. Thus, if firm A and B are separate, the tax authority will get $68 as tax regardless of the which state occurs. However, if firms A and B merge, the combined firm will pay $34 in taxes under both state I and state II. Before Merger After Merger Firm A Firm B Firm AB State I State II State I State II State I State II Taxable income 200 -100 -100 200 100 100 Taxes 68 0 0 68 34 34 Net income 132 -100 -100 132 66 66

29.5 Source of Synergy from Acquisitions

Unused Debt Capacity Because some diversification occurs when firms merge, therefore, the cost of financial distress is likely to be less for the combined firm than it is for the two separate firms. As stated earlier, the optimum debt equity ratio is the one where the marginal tax benefit from additional debt is equal to the marginal cost of increased financial distress. As for the combined firm the financial distress cost decreases, it helps in increasing the amount of debt i.e. its debt capacity as well as tax benefits and value are increased.

29.5 Source of Synergy from Acquisitions

Surplus Funds A firm that has free cash flow, apart from purchasing fixedincome securities, it can use the fund in paying dividends, buying back shares, or acquiring shares in another firm. If dividends are paid this may increase the income tax of some of the stockholders. Alternatively, in case of share repurchase tax liability is less, however, this can not be practiced solely to avoid taxes. The firm can buy shares of another firm. This results in avoidance of taxes on dividend income and payment of little corporate taxes on dividends received from the shares purchased from other firms. However, this can not be practiced for long time as tax authority does not allow.

29.5 Source of Synergy from Acquisitions

Surplus Funds In case of acquisition with the excess funds no taxes are at all paid on dividends remitted from the acquired firm and there is no restriction from the tax authority in this type of merger. The Cost of Capital The cost of capital can often be reduced when two firms merge because cost of issuing securities are subject to economies of scale. The costs of debt and equity are much lower for larger issues than for smaller issues.

29.6 Calculating the Value of the Firm after an Acquisition

Example: Pages 806 807 and Table 29.4 Avoiding Mistakes
Do not Ignore Market Values It is sometimes difficult to estimate values using discounted cash flow techniques. Estimate only Incremental Cash Flows Because only the incremental cash flows from acquisition add value to the bidding firm, as such, only the incremental cash flows should be estimated and considered.

29.6 Calculating the Value of the Firm after an Acquisition

Avoiding Mistakes
Use the Correct Discount Rate The required rate of return for the incremental cash flows should be the discount rate or cost of capital for valuation and not the bidding firms cost of capital. Dont Forget Transactions Costs Transaction costs such as legal fees, investment bankers fees, etc. should

29.7 A Cost to Stockholders from Reduction in Risk

In case of levered firm, the gains from a merger are likely to be shared by both bondholders and stockholders. The bondholders are usually benefited from a merger at the expense of the stockholders. When two firms merge the variability of their combined values is usually less than that if the firms remained as separate entities. The reduction in the variability of firm values can occur if the correlation between the values of two firms is less than perfect. The reduction in the variability can reduce the cost of borrowing and make the creditors better off than before. This will happen if the merger reduces the probability of financial distress.

29.7 A Cost to Stockholders from Reduction in Risk

Ultimately, the stockholders are likely to be worse off. The gain to the creditors are at the expense of the stockholders if the total value of the firm does not change after merger. The relationship among the value of the merged firm, debt capacity, and risk is very complicated. In this regard, the following examples are given.

The Base Case

First, the case of two all equity firms A and B is considered. Under three possible states of the economy viz. prosperity, average, and depression, the weighted average of the market values of firm A and B have been

29.7 A Cost to Stockholders from Reduction in Risk

The Base Case
determined. When the two firms merge, the combined value is $100. There is no synergy from this merger and consequently the value of firm AB is sum of the values of firm A and firm B. The stockholders of firm B receives $40 and the stockholders of firm A have a value of $60. Therefore, the stockholders of both the firma are indifferent to the proposed merger.

29.7 A Cost to Stockholders from Reduction in Risk

One Firm is Levered
Alternatively, if firm A is levered, it will default when there is recession because its NPV under depression is $25 and debt claim is $40. The creditors consider this and they value the debt as $37 (i.e. 40 x 0.5 + 40 x 0.3 + 40 x 0.2). Although default occurs without merger but it does not occur with a merger. When two firms are separate, firm B has nothing to do with firm As debt. However, when the two firms merge, the cash flows of both the firms can be used to meet the debt obligations. This is known as coinsurance effect and it makes the debt less risky and more valuable than before.

29.7 A Cost to Stockholders from Reduction in Risk

One Firm is Levered
The bonds are worth $40 after the merger. Thus, the bondholders of AB gain $3 ($40 - $37) from the merger. On the other hand, the stockholders of firm A lose $3 ($20 - $23) from the merger. This is because the stockholders of firm AB holds stock worth of $60 out which the stockholders of firm B receive $40 and the rest belongs to the stockholders of firm A i.e. $20. There is no net benefit for the firm as a whole. The following conclusions emerged from the above analysis: The bondholders as whole usually are benefited from merger and acquisitions. The less risky the combined firm is, the greater are the gains to bondholders.

29.7 A Cost to Stockholders from Reduction in Risk

One Firm is Levered
The stockholders of the bidding firm will be hurt by the amount that bondholders gain. The above conclusions are applicable to those mergers and acquisitions where no synergy is present. If there is synergy, then most of the things depends on the size of the synergy.

How can Stockholders Reduce Their Losses from the Coinsurance Effect?
There are at least two ways that stockholders can reduce or eliminate the coinsurance effect. First, the stockholders in firm A can retire the entire debt before the merger

29.7 A Cost to Stockholders from Reduction in Risk

How can Stockholders Reduce Their Losses from the Coinsurance Effect?
announcement date and reissue equal amount of debt after merger. As the debt can be retired at a lower price before the merger, this type of refinance transaction will neutralize the coinsurance effect to the bondholders. Secondly, the stockholders may increase the amount of debt after merger. This will increase the tax benefits from increased interest expense as well as the value of the firm. Moreover, as the firms probability of financial distress increases with additional debt, it will reduce or eliminate the bondholders gain from the coinsurance effect.

29.8 Two "Bad" Reasons for Mergers

Earnings Growth An acquisition can create the
appearance of earnings growth, which may fool investors into thinking that the firm is worth more than it really is. For example, firm GR acquires firm RE. The financial positions of both the firms before the acquisition are shown in the table. After Merger
Before Merger Glob Resources Glob Resrc. Regionl Ent. Smart Fooled EPS 1 1 1.43 1.43 PPS 25 10 25 35.71 PE Ratio 25 10 17.5 25 No. of Shares 100 100 140 140 Total Earnings 100 100 200 200 Total Value 2500 1000 3500 5000

29.8 Two "Bad" Reasons for Mergers

Earnings Growth
. An acquisition can create the appearance of earnings growth, which may fool investors into thinking that the firm is worth more than it really is. For example, firm GR acquires firm RE. The financial positions of both the firms before the acquisition are shown in the table. The firm RE has poor performance compared to that of firm GR. The merger creates no additional value. If the market is smart, it will value the combined firm as the sum of the values of the two separate firms, which is $3,500 in the table. At this condition, firm GR will acquire firm RE by exchanging 40 of its shares for 100 shares of RE, so GR

29.8 Two "Bad" Reasons for Mergers

Earnings Growth
will have 140 shares outstanding after the merger. The stock price after the merger is the same after the merger, therefore, the price earnings ratio must fall. Now if the market is fooled, it is shown in the table that acquisition enables GR to increase its EPS from $1 to $1.43. In this case, by mistake the market will consider this 43% increase to be true growth. The PE ratio may not fall and if it remains at 25, then total combined firm value will be $5,000 (25 x $200) and the PPS of GR will be $35.71 ($5,000/140) which is shown in the table. This is an illusion and will be corrected soon by the efficient market activities and the value of the combined firm will decline.

29.8 Two "Bad" Reasons for Mergers

Diversification
It is often mentioned that one of the benefits of merger and acquisition is diversification. However, diversification by itself can not increase firm value. The variability of firms return has two components one is firm specific known as unsystematic and the other is common to all known as systematic. Merger will not reduce or eliminate the systematic variability as diversification has no impact on it (systematic variability). Whereas, unsystematic variability can be eliminated by diversification, however, to accomplish this shareholders do not require diversified companies they can diversify more easily and less costly than corporations by simply purchasing the stocks of different companies.

29.8 Two "Bad" Reasons for Mergers

Diversification
Diversification can produce gains to the bidding firm only if two things are true:

1. Diversification decreases the unsystematic variability at lower costs than by shareholders. This is very unlikely.
2. Diversification reduces risk and thereby increases debt capacity. (This possibility has been discussed earlier).

29.9 The NPV of a Merger

Typically, a firm uses NPV analysis when making acquisitions. The analysis is straightforward with a cash offer, but gets complicated when the consideration is stock.

Cash
Example: Firm A and firm B have values $500 and $100 as separate entities respectively. If firm A acquires firm B, the combined firm AB will have value of $700 due to synergy of $100. The board of firm B has indicated that it will sell firm B if it is offered $150 in cash. Is it worthwhile for firm A to acquire firm B? Value of firm A after acquisition = Value of combined firm Cash paid = 700 150 = 550

29.9 The NPV of a Merger

Cash
Firm A worth $500 prior to the acquisition, the NPV to firm As stockholders is $550 - $500 = $50 If there are 25 shares outstanding of firm A, before acquisition each share worth $500 25 = $20 and $22 ($550 25) after the merger. The calculations are shown in the following table.

Before Acquisition Firm A Firm B Cash Mrkt. Value VA, VB 500 100 150 Number of Shares 25 10 25 Price per share 20 10 22

29.9 The NPV of a Merger

Cash
The NPV of a merger in reference to synergy and premium can also be determined as follows: NPV of a merger to bidder = Synergy Premium Synergy = VAB (VA + VB) Premium = Price paid for B VB Therefore, NPV of a merger to bidder = VAB VA Price paid for B VA = 500 VB = 100 VAB = 700 Price paid for B = 150

29.9 The NPV of a Merger

Cash
Synergy = VAB (VA + VB) = 700 ( 500 + 100 )
= 700 600 = 100 Premium = Price paid for B VB =150 - 100 = 50 NPV of a merger to bidder = Synergy Premium = 100 50 = 50 OR NPV of a merger to bidder = VAB VA Price paid for B = 700 500 150 = 50

29.9 The NPV of a Merger

Cash The value of firm A without the merger is $500, however, when merger negotiations are in progress, the firm As market value must greater than $500. This is because the market price reflects the possibility of the merger. If the probability of merger is 60% the market value of firm A will be as follows: Market value of A = Market value of A with merger x probability of merger + Market value of A without merger x probability of no merger = 550 x 0.60 + 500 x 0.40 = 330 + 200 = 530

29.9 The NPV of a Merger

The mangers will underestimate the NPV from merger if the market value of A is used. Thus managers are faced with the difficult task of valuing their own firm without the acquisition.

Common Stock
The firm A can acquire firm B with common stock instead of cash. In this regard, it is necessary to determine the number of shares outstanding of firm B. It is assumed that there are 10 shares outstanding as indicated in the previous table. Let firm A exchanges 7.5 of its shares for 10 shares of firm B. Therefore, the exchange ratio is 0.75:1. The value of each share of firm As stock before the acquisition is $20. Because, 7.5 x 20 = $150, the exchange appears to be equivalent of purchasing firm B in cash for $150. This is incorrect.The true cost is greater than $150.Firm A has

29.9 The NPV of a Merger

Common Stock
32.5 (7.5 + 25 ) shares outstanding after the merger. Firm B owned 23% (7.5/32.5) of the combined firm. Their holdings are valued at $161 (23% of $700). Because these stockholders receive stock in firm A worth $161, the cost of the merger to firm As stockholders must be $161 not $150. The result is shown in the table. After Acquisition Firm A
Common Stock Common Stock Exchange Ratio Exchange Ratio (0.75: 1) (0.6819: 1) Mrkt. Value VA, VB 700 700 Number of Shares 32.5 31.819 Price per share 21.54 22

29.9 The NPV of a Merger

Common Stock
The value of each share of firm As stock after a stock-for-stock transaction is only $21.54 ($700/32.5). Under cash for stock transaction it was $22. This is because of the higher cost of stock-for-stock transaction. This type of result occurs because the exchange ratio is based on the premerger prices of the two firms. However, the fact is price of firm As stock rises after merger and firm Bs stockholders receive more than $150 in firm A stock. What should the exchange ratio be so that firm Bs stockholders receive only $150 of firm As stock? Let proportion of the shares in the combined firm that firm Bs stockholders own is . As the combined firms value is $700, value of firm Bs stockholders after the merger is x $700 which is equal to $150. Therefore, = .2143 or 21.43%. In other words, firm Bs stockholders will receive stock worth $150 if they receive 21.43% of the firm after merger.

The NPV of a Merger: Common Stock

The number of shares issued to firm Bs stockholders can be determined as follows: The proportion , that firm Bs shareholders have in the combined firm can be expressed as

a=

New shares issued Old shares + New shares issued

=> 0.2143 = New shares issued (25 + New shares issued ) => New shares issued = 6.819

29.9 The NPV of a Merger

Cash Firm A worth $500 prior to the acquisition, the NPV to firm As stockholders is $550 - $500 = $50 If there are 25 shares outstanding of firm A, before acquisition each share worth $500 25 = $20 and $22 ($550 25) after the merger. The calculations are shown in the following table.

and firm B have values $500 and $100 as separate entities respectively. If firm A acquires firm B, the combined firm AB will have value of $700 due to synergy of $100. The board of firm B has indicated that it will sell firm B if it is offered $150 in cash. Is it worthwhile for firm A to acquire firm B? Value of firm A after acquisition = Value of combd. Firm Cash paid = 700 150 = 550