Question

1. ABC has 1 million shares outstanding, each of which has a price of $25. It has made a takeover offer of XYZ Corporation, which has 1 million shares outstanding and a price per share of $2.59. Assume that the takeover will occur with certainty and all market participants know this. Furthermore, there are no synergies to merging the two firms.

a.         Assume ABC made a cash offer to purchase XYZ for $4 million. What happens to the price of ABC and XYZ on the announcement? What premium over the current market price does this offer represent??

b.         Assume ABC makes a stock offer with an exchange ratio of 0.16. What happens to the price of ABC and XYZ this time? What premium over the current market price does this offer represent?

c.         At current market prices, both offers are offers to purchase XYZ for $4 million. Does that mean that your answers to parts (a) and (b) must be identical? Explain.

Answer 1

a) The price of the XYZ Corporation :-

The abc corporation is offered $4 million .

The price of the XYZ corporation is 4,000,000 / 1,000,000 = $4 per share

Premium = ( price per share offering - current market price ) / current market price

Premium = ($4 - $ 2.59) / 2.59

Premium = 54.44% premium

The combined firm value will be $25 million + 2.59 million = $ 27.59 million

The market cap of ABC falls to = $ 27.59 million - $ 4 million = $ 23.59 million

The price per share of ABC falls to $ 23.59 per share ( $23.59 million / 1million share)

B) ABC makes a stock offer with an exchange ratio of 0.16

That means if firm combined value is 1.16. the ABC. Stockholders own 1/1.16 of the combined value.XYZ. Stockholders own 0.16/1.16 of the combined value.

The combined value will be $ 27.59 million.

The ABC stockholders now own = 27.59 million * 1/1.16 = $23.78 million

The Per share value of the ABC stockholders own = 23.78 million / 1 million = $23.78 per share.

The XYZ corporation stockholders now own = $ 27.59 million * 0.16/1.16 = $ 3.81 million

The per share value of the XYZ Corporation stockholders own = $3.81 million / 1 million shares = $3.81 per share.

The premium = (3.81 - 2.59 )/2.59 = 47.10% premium

C) No,the premium in the stock offer is lower because market prices change to reflect the fact that ABC shareholders are giving XYZ shareholders money because they are paying a premium.The part b offer XYZ stock goes up & ABC stock goes up compare to the part a offer.