As a financial manager of Firm A you have been asked to analyze a potential acquisition of firm B. You have the following data:

Firm A. Firm B

number of shares. 1,000,000 800,000

stock price. $40 $25

Per share. Per share

Assume that the current stock price accurately reflects intrinsic value of the shares of both firms. Your estimate that the merger will provide cost savings of $1,000,000 per year forever. Your firm (A) can pay either $28,000,000 in cash or offer 3 shares of firm A for every 4 shares of firm B. The relevant discount rate is 10%.

a) compute the gain from merger.

b) compute the cost of the cash offer.

c) compute the cost of the stock offer.

d) compute the NPV of the acquisition under stock offer.

e) now assume that firm A overestimate the value of firm B. Which offer is better from standpoint of firm A's shareholders. Explain.