Module 25.4 LOS 25.k, 25.i: Post-acquisition value created using different payment methods

For mergers to occur in a rational sense, the value of the combined firm should be worth more than the sum of the two separate firms.

Post-merger value of an acquirer:

 VAT = VA + VT + S − C


VAT= post-merger value of the combined company (acquirer + target)

VA = pre-merger value of acquirer

VT = pre-merger value of target

S = synergies created by the merger

C = cash paid to target shareholders

Acquirers will usually pay a takeover premium to the target shareholders in order to obtain approval.

Gains Accrued to the Target

GainT = TP = PT − VT


GainT = gains accrued to target shareholders

TP = takeover premium

PT = price paid for target

VT = pre-merger value of target

Acquirers pay the premium because they expect the synergies they gain to exceed the premium.

Gains Accrued to the Acquirer

GainA = S − TP = S − (PT − VT)


GainA = gains accrued to the acquirer’s shareholders

Acquirers can offer target shareholders cash, stock or cash and stock in a takeover offer. Cash offers are simpler to account for as the gains to shareholders will be fixed, but stock offers enable target shareholders to profit from the value of the merged company.

PT = (N × PAT)


N = number of new shares the target receives

PAT = price per share of combined firm after the merger announcement

A cash offer puts risk on the acquirer, with a capped gain for target shareholders. However acquirers can earn an uncapped premium if synergies are greater than anticipated.

In stock offers, some of that risks shifts to the target firm, though stock offers can be more costly to the acquiring firm due to stock dilution. The choice often comes down to the certainty that synergies will be realize. If there is high confidence in the value of synergies, both companies may prefer a cash offer.

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