Your company has earnings per share of $ 5 It has 1 million shares? outstanding,

Question

Your company has earnings per share of $ 5 It has 1 million shares? outstanding, each of which has a price of $ 36. You are thinking of buying? TargetCo, which has earnings of $ 3 per? share, 1 million shares? outstanding, and a price per share of $30 You will pay for TargetCo by issuing new shares. There are no expected synergies from the transaction. Suppose you offered an exchange ratio such? that, at current? pre-announcement share prices for both? firms, the offer represents a 23 % premium to buy TargetCo. ? However, the actual premium that your company will pay for TargetCo when it completes the transaction will not be 23 %, because on the announcement the target price will go up and your price will go down to reflect the fact that you are willing to pay a premium for TargetCo without any synergies. Assume that the takeover will occur with certainty and all market participants know this on the announcement of the takeover? (ignore time value of? money).

a. What is the price per share of the combined corporation immediately after the merger is? completed?

b. What is the price of your company immediately after the? announcement?

c. What is the price of TargetCo immediately after the? announcement?

d. What is the actual premium your company will? pay?

Explanation / Answer

Part a)

Step 1: Calculate the Number of New Shares to be Issued to Buy Target Company

The number of new shares to be issued to buy target company is arrived as below:

Number of New Shares to be Issued to Buy Target Company = Current Share Price of Target Company*(1+Premium Paid)/Current Share Price of Your Compant = 30*(1+23%)/36 = 1.025 million shares

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Step 2: Calculate Price Per share of the Combined Corporation Immediately After the Merger is Completed

The price per share of the combined corporation immediately after the merger is completed is determined as follows:

Price Per Share of the Combined Corporation Immediately After the Merger is Completed = (Current Share Price of Your Company + Current Share Price of Target Company)/(Current Outstanding Shares of Your Company + New Shares Issued)

Substituting values in the above formula, we get,

Price Per Share of the Combined Corporation Immediately After the Merger is Completed = (36 + 30)/(1+1.025) = $32.593 or $32.59

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Part b)

The price of your company immediately after the announcement would be same as calculated in Part a).

Price of Your Company Immediately after Announcement = $32.593 or $32.59

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Part c)

The price of target company immediately after the announcement is determined as below:

Price of Target Company Immediately After the Announcement = (Shares Received by Target Company Shareholders*Price Per Share of the Combined Corporation Immediately After the Merger)/Total Number of Outstanding Shares of Target Company

Substituting values in the above formula, we get,

Price of Target Company Immediately After the Announcement = (1.025*32.593)/1 = $33.408 or $33.41

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Part d)

The value of actual premium your company will pay is calculated as below:

Actual Premium Your Company will Pay = Price of Target Company Immediately After the Announcement/Price of Target Company before Merger - 1 = 33.408/30 - 1 = 11.36%

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