Question

Consider two firms, CompanyB and CompanyC, both with earnings of $10 per share and 5 million shares outstanding. CompanyC is a mature company with few growth opportunities and a stock price of $25 per share. CompanyB is a new firm with much higher growth opportunities and a stock price of $40 per share. Assume CompanyB acquires CompanyC using its own stock and the takeover adds no value. In a perfect capital market, how many shares must Bob offer CompanyC's shareholders in exchange for their shares?

A) 0.625
B) 1
C) 0.3846
D) 1.6

Answer 1

CompanyB must offer 0.625 of its shares for each share of CompanyC, resulting in the issuance of 3,125,000 shares of CompanyB in total to acquire CompanyC.

Step-by-step explanation:

The question involves figuring out the number of shares CompanyB must offer to CompanyC's shareholders in a stock-for-stock acquisition. Given that CompanyC's stock price is $25 per share and CompanyB's stock price is $40 per share, an acquisition adding no extra value means that the exchange ratio is determined by the ratio of these stock prices. The exchange ratio is the CompanyC's share price divided by CompanyB's share price, which is $25/$40 = 0.625. Therefore, for each share of CompanyC, CompanyB must offer 0.625 of its own shares.

To obtain the total number of shares CompanyB should issue, we multiply the exchange ratio by the number of outstanding shares of CompanyC. With 5 million shares outstanding for CompanyC, the math is 0.625 * 5,000,000 = 3,125,000 shares. Thus, CompanyB must issue 3,125,000 of its own shares to the shareholders of CompanyC in exchange for all outstanding shares of CompanyC.