Company A has 10 million shares trading at a price of $9m, as investors view it should be

$10 or $8 with equal probabilities. However, its management knows the true value per

share is $10. The company is planning the acquisition of company T, which has 4 million

shares trading at $15. Advisors tell company A it will have to pay a 20% premium for

company T's shares over their current price. The acquisition would create synergies worth

$15m. If the deal is to go through, company A will pay company Ts shareholders with new

shares of company A.

As a benchmark, assume markets also know true value per share to be $10.

a. What will be As market capitalization after acquiring T? What fraction of its equity

will be held by former T shareholders? What will be its value? What fraction of

shares will As existing shareholders retain? What will be its value? What gains will

As shareholders (as a group) and Ts shareholders (as a group) realize respectively

in the acquisition?

Now take into account that As management know the shares are worth $10 and underpriced at

$9. Investors (including Ts shareholders) being aware of that, management must consider their

reaction to the acquisitions announcement. A priori, three scenarios are possible:

Scenario 1: Investors would infer nothing about the value.

Scenario 2: Investors would infer the value per share is $8.

Scenario 3: Investors would infer it is $10.

b. For each scenario, how much would Ts shareholders value As equity post-

acquisition? What fraction of its equity will they demand (as a group) as payment

for Ts shares?

c. For each scenario, if managers knew the value was $8, would they do the

acquisition?

d. For each scenario, since they know the value is $10, would they agree to the

acquisition?

e. Summarize your finding by filling each cell of the table with Go or No Go

Investors believe the share value is... $8 Average $10 $10 the share value is... Managers know $8