Firm A has a stock price of $40, and has made an offer for firm B where A promises to pay 1.5 shares for each share of B, as long as A’s stock price remains between $35 and $45. If the price of A is below $35, A will pay $52.50/share, and if the price of A is above $45, A will pay $67.50/share. The deal is expected to close in 9 months.
Assume σ = 40%, r = 6%, and δ = 0.
a. How are the values $52.50 and $67.50 arrived at?
b. What is the value of the offer?
c. How does the value of this offer compare with that in Problem 16.20?