Firm A plans to acquire Firm B by making a cash offer of $27 a share for all 100

Question

Firm A plans to acquire Firm B by making a cash offer of $27 a share for all 100,000 shares of B. It estimates that the merger will produce cost savings with a present value of $800,000. Recently, Firm B's stock price increased from $20 to $24 per share, evidently due to its excellent financial performance. Firm A thus estimates Firm B's stand-alone price at $24. However, the CFO suggests a reevaluation of the offer, pointing out that the true stand-alone value of Firm B may be $20 per share, not $24 per share. If the stand-alone value is $20 per share, will the merger still generate positive NPV for Firm A?

A. No. The cost to acquire Firm B will exceed the postmerger gain of $800,000.

B. No. Firm A will break even, since the costs are $400,000 more than expected.

C. Yes. Firm A will still make a gain, although Firm B captures more of the economic gain than expected.

D. Yes. Since the market is efficient, the true stand-alone value of Firm B is $24 per share and the CFO's fear is unwarranted.

Explanation / Answer

C.Yes.Frim A will still make a gain although firm B captures more of the economic gain than expected.

Total gain from merger = $800,000.

Gain to FIrm A is calculated below:

out of a total gain of $800,000 only $100,000 belongs to firm A , remaning $700,000 belongs to firm B.

stand alone value of Firm B ($20 * 100,000 shares) $20,00,000 add: gain from merger $800,000 less: price paid to firm B ($27 * 100,000) (27,00,000) Gain to Firm A $100,000

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