Question

1. Firm X is being acquired by Firm Y for $35,000 worth of Firm Y stock (valued at the pre-merger current price of Y). Both firms are “all-equity” financed. The incremental value created by the merger is $2,500. Firm X has 2,000 shares of stock outstanding at $16 per share. Firm Y has 1,200 shares of stock outstanding at a price of $40 per share. What is the actual cost of the acquisition to Firm Y using company stock? Why is the actual cost less than $35,000?

Answer 1

Firm X is being acquired by Firm Y for $35,000 worth of Firm Y stock

Therefore, number of shares issued = Acquisition price/ Stock price of Y

Where, Acquisition price = $35,000

And Stock price of Y = $40

Therefore, number of shares issued = $35,000/$40 = 875 shares

Value per share after merger = {(number of stock outstanding of stock X * Stock price of X + number of stock outstanding of stock Y * Stock price of Y) + incremental value created by the merger}/ (number of stock outstanding of stock Y + number of shares issued)

= {(2000 * $16 + 1,200 * $40) + $2500}/ (1,200 + 875)

= {(2,000 * $16) + 1,200 *$40) + $2,500} / (1,200 + 875)

= $82,500/ 2,075 = $39.76

Therefore the actual cost of acquisition to Firm Y using company stock = number of shares issued * Value per share after merger

= 875 * $39.76 = $34,789.16 or $34,789

The actual cost is $34,789 which is less than $35,000 because value per share after merger is less than the actual Stock price of Y