Question

Your company has earnings per share of $5. It has 1 million shares​ outstanding, each of which has a price of $36. You are thinking of buying​ TargetCo, which has earnings per share of $1​, 1 million shares​ outstanding, and a price per share of $23.

You will pay for TargetCo by issuing new shares. There are no expected synergies from the transaction. Suppose you offer an exchange ratio such​ that, at current​ pre-announcement share prices for both​ firms, the offer represents a 15% premium to buy TargetCo. Assume that on the announcement the target price will go up and your price will go down to reflect the fact that you are willing to pay a premium for TargetCo. Assume that the takeover will occur with certainty and all market participants know this on the announcement of the takeover.

a. What is the price per share of the combined corporation immediately after the merger is​ completed?

b. What is the price of your company immediately after the​ announcement?

c. What is the price of TargetCo immediately after the​ announcement?

d. What is the actual premium your company will​ pay?

Answer 1

All amounts are in $

a.

Once the merger is completed, all the assets and liabilities of the target company incorporated into the acquirer company's accounts.

Price per share will remain same 36 per share as it is before the merger announcement for the acquisition company's because all the assets and liabilities of target company are brought into the acquirer's books. (Including goodwill paid on acquisition - 15% premium)

b.

The price of the company immediately after announcement will reduce as it is paying extra amount for acquisition as premium

Net book value/ net market value before announcement = 36 x 1 million shares = $36 million

If purchase takes place = 36 million - 15%(23 million) = $32.55 millions

So price after announcement will be = 32.55 millions / 1 million shares = 32.55 per share

c.

The price of target company immediately after announcement will increase there is a premium paid for its stock

New share price = 23 x 115% = 26.45 per share

d.

The premium the company will pay is 3.45 per share (23 x 15%).

Total premium will be $3.45 millions (3.45 x 1 million shares)