Once the value of the target company is determined

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Unformatted text preview: action An acquisition method in which the acquiring firm exchanges its shares for shares of the target company according to a predetermined ratio. Once the value of the target company is determined, the acquirer must develop a proposed financing package. The simplest (but probably the least common) case is a pure cash purchase. Beyond this extreme case, there are virtually an infinite number of financing packages that use various combinations of cash, debt, preferred stock, and common stock. Here we look at the other extreme—stock swap transactions, in which the acquisition is paid for using an exchange of common stock. The acquiring firm exchanges its shares for shares of the target company according to a predetermined ratio. The ratio of exchange of shares is determined in the merger negotiations. This ratio affects the various financial yardsticks that are used by existing and prospective shareholders to value the merged firm’s shares. With the demise of LBOs, the use of stock swaps to finance mergers has grown in popularity during recent years. Ratio of Exchange When one firm swaps its stock for the shares of another firm, the firms must determine the number of shares of the acquiring firm to be exchanged for each share of the target firm. The first requirement, of course, is that the acquiring company have sufficient shares available to complete the transaction. Often, a firm’s repurchase of shares (discussed in Chapter 13) is necessary to obtain sufficient shares for such a transaction. The acquiring firm generally offers more for 724 PART 6 Special Topics in Managerial Finance ratio of exchange The ratio of the amount paid per share of the target company to the market price per share of the acquiring firm. EXAMPLE each share of the target company than the current market price of its publicly traded shares. The actual ratio of exchange is merely the ratio of the amount paid per share of the target company to the market price per share of the acquiring firm. It is calculated in this manner because the acquiring firm pays the target firm in stock, which has a value equal to its market price. Grand Company, a leather products concern, whose stock is currently selling for $80 per share, is interested in acquiring Small Company, a producer of belts. To prepare for the acquisition, Grand has been repurchasing its own shares over the past 3 years. Small’s stock is currently selling for $75 per share, but in the merger negotiations, Grand has found it necessary to offer Small $110 per share. Because Grand does not have sufficient financial resources to purchase the firm for cash and does not wish to raise these funds, Small has agreed to accept Grand’s stock in exchange for its shares. As stated, Grand’s stock currently sells for $80 per share, and it must pay $110 per share for Small’s stock. Therefore, the ratio of exchange is 1.375 ($110 $80). This means that Grand Company must exchange 1.375 shares of its stock for each share of Small’s stock. Effect on Earnings Per Share Although cash flows and value are the primary focus...
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This document was uploaded on 01/19/2014.

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