Question
Firm Alpha is considering acquiring firm Beta. Beta's value under current management, v, is uniformly distributed between $0 and $50 million, depending on the outcome
Firm Alpha is considering acquiring firm Beta. Beta's value under current management, v, is uniformly distributed between $0 and $50 million, depending on the outcome of a risky project. Beta knows the outcome of the project and hence the value v, but Alpha only knows that v is uniformly distributed between 0 and 50. Regardless of the outcome of the project, T is worth 25% more to Alpha than Beta (Alpha values Beta at 1.25v), so for example if Beta is worth $50 to Beta, the company is worth $62.5 to Alpha. Alpha makes a single take-it-or-leave-it offer for Beta, which Beta accepts or rejects. Both firms are risk neutral. Recall: the probability of drawing any particular value from a uniform distribution between numbers a and b (with a < b) is 1 ba . The expected value of a draw from a uniform distribution between a and b is a+b 2 . (a) Explain what is meant by the winner's curse (generally, not specifically for this problem). (b) Explain how the winner's curse is related to Alpha's problem. (c) Write down the payoff function Alpha should be maximizing. (d) What offer should Alpha make to Beta?
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