Firm A wants to acquire Firm B. Recently, Firm B\'s stock price increased from $

Question

Firm A wants to acquire Firm B. 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. Firm A intends to purchase all 100,000 shares of Firm B for $27 per share (cash offer), expecting a postmerger gain of $800,000. However, the CFO suggests a re-evaluation of the offer, pointing out that the true stand-alone value 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?

Explanation / Answer

Answer:

Present Value of Current Outflow = ($ 27 - $ 20) x 100,000 = $ 700,000 (being excess value paid over and above stand alone value of Firm B's share of $ 20)

Present Value of Expected Inflows = $ 800,000 (being expected post merger gain)

Net Present Value = PV of expected inflows - PV of current inflows = $ 800,000 - $ 700,000 = $ 100,000

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

Related Questions

Navigate

• Browse (All)
• Browse F
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.