Question

Firm A is worth $200 million as an independent firm and Firm B is worth $30 million as an independent firm. Firm A currently has 4 million shares outstanding and Firm B has 6 million shares outstanding. If the firm's merge the total value of the merged firm is $240 million. Suppose Firm A offers to buy Firm B for $6.50 a share and the boards of both firms have agreed to the deal. However, the market is unsure whether regulators will approve the merger and thus they believe that the deal will only go through with a probability of 1/2. Given this information: (a) What would the stock price of Firm B to be immediately after the announcement of the merger agreement

Answer 1

The stock price of Firm B to be immediately after the announcement of the merger agreement is:

= $5.75

Step-by-step explanation:

a) Data and Calculations:

Worth of Firm A as an independent firm = $200 million

Firm A's outstanding shares = 4 million

Share price of Firm A = $50 ($200/4) per share

Worth of Firm B as an independent firm = $30 million

Firm B's outstanding shares = 6 million

Share price of Firm B = $5 ($30/6) per share

The total value of the merged firm (Firm A & B) = $240 million

Price offered for Firm B = $6.50

Probability of deal going through = 0.5 (1/2)

Probability of deal not going through = 0.5 (1 - 0.5)

Value of Firm B with deal going through = $39 million ($6.50 * 6 million)

Value of Firm B with deal not going through = $30 million

Expected value of Firm B under probability = ($39 * 0.5) + ($30 * 0.5) million

= $34.5 million

Share price of Firm B = $5.75 ($34.5 million/ 6 million)

b) The share price of Firm B immediately after the announcement of the merger agreement will depend on the expected values of the deal going through and the deal not going through. These are weighted and then divided by the number of outstanding shares to get the price per share.