Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVIII. Topics in Corporate
Finance- Mergers and
Acquisitions
(^882) © The McGraw−Hill
Companies, 2002
To give $150 worth of stock for Firm B, Firm A will have to give up $150/20 7.5
shares. After the merger, there will be 25 7.5 32.5 shares outstanding, and the per-
share value will be $700/32.5 $21.54.
Notice that the per-share price after the merger is lower under the stock purchase op-
tion. The reason has to do with the fact that B’s shareholders own stock in the new firm.
It appears that Firm A paid $150 for Firm B. However, it actually paid more than that.
When all is said and done, B’s stockholders own 7.5 shares of stock in the merged firm.
After the merger, each of these shares is worth $21.54. The total value of the considera-
tion received by B’s stockholders is thus 7.5 $21.54 $161.55.
This $161.55 is the true cost of the acquisition because it is what the sellers actually
end up receiving. The NPV of the merger to Firm A is:
NPVVB*Cost
$200 161.55 $38.45
We can check this by noting that A started with 25 shares worth $20 each. The gain to A
of $38.45 works out to be $38.45/25 $1.54 per share. The value of the stock has in-
creased to $21.54, as we calculated.
When we compare the cash acquisition to the stock acquisition, we see that the cash
acquisition is better in this case, because Firm A gets to keep all of the NPV if it pays in
cash. If it pays in stock, Firm B’s stockholders share in the NPV by becoming new
stockholders in A.
Cash versus Common Stock
The distinction between cash and common stock financing in a merger is an important
one. If cash is used, the cost of an acquisition is not dependent on the acquisition gains.
All other things being the same, if common stock is used, the cost is higher because
Firm A’s shareholders must share the acquisition gains with the shareholders of Firm B.
However, if the NPV of the acquisition is negative, then the loss will be shared between
the two firms.
Whether a firm should finance an acquisition with cash or with shares of stock de-
pends on several factors, including the following:
1.Sharing gains.If cash is used to finance an acquisition, the selling firm’s
shareholders will not participate in the potential gains from the merger. Of course,
if the acquisition is not a success, the losses will not be shared, and shareholders of
the acquiring firm will be worse off than if stock had been used.
2.Taxes.Acquisition by paying cash usually results in a taxable transaction.
Acquisition by exchanging stock is generally tax-free.
3.Control.Acquisition by paying cash does not affect the control of the acquiring firm.
Acquisition with voting shares may have implications for control of the merged firm.
In the 1980s, cash deals were the rule. In the 1990s, stock deals became much more
common. Today, cash deals are relatively rare, at least in large mergers.
CONCEPT QUESTIONS
25.6a Why does the true cost of a stock acquisition depend on the gain from the
merger?
25.6bWhat are some important factors in deciding whether to use stock or cash in an
acquisition?
858 PART EIGHT Topics in Corporate Finance