Question 2 (14 points) UnderCo has 10M shares outstanding with shares trading at $8/share. One day UnderCo is targeted by a hostile tender offer for $9/share.

UnderCos management owns 40% of the firm, and will not sell its shares. In order to fend off the bid, management plans to make a competing tender offer to public investors. The company will borrow $30M and use the proceeds to finance the self-tender. UnderCo is initially 100% equity financed.

UnderCo faces a corporate tax rate of 50%. Assume UnderCo maintains the level of debt, and that interest tax shields are as risky as the debt.

a)Assume UnderCo announces an offer for $9.20/share. This would be a partial tender offer, the size of which is limited by the amount of debt proceeds. Will shareholders tender? Explain using numbers. (Hint: First compute how much the company is worth after borrowing $30M and using it all to buy back shares. Now compute the price of non-tendered shares assuming the bid is successful and compare it with the tender offer)

b) If UnderCo offers $10, will shareholders tender? Explain using numbers.

c) Can the self-tender offer in (b) successfully fend off the hostile takeover? Explain using numbers.