Exco plc is planning to separate one of its subsidiaries ('SplitCo'), through a split-off of the entire share capital of SplitCo, amounting to 1 million shares outstanding.

The estimated value of SplitCo's shares (before the split-off) is 3 per share. Exco plc's shares are currently trading at a market price of 6 per share.

Exco's directors need to set the value of the share exchange ratio and are considering two alternative ratios:

a) 3:1 ratio (i.e. exchanging 3 SplitCo shares for 1 Exco share)

b) 2:1 ratio (i.e. exchanging 2 SplitCo shares for 1 Exco share)

Question 1

Compute the total value of the Exco shares to be exchanged in the split-off under each of the two alternative exchange ratios shown in a) and b) above, assuming that the offer is fully subscribed.

Question2

What advice would you give to Exco's directors about choosing the exchange ratio? Set your suggested exchange ratio, explaining the reasons for your choice. Your answer should include an explanation of the pros and cons of using the two alternative exchange ratios shown in a) and b) above.