Firm A plans to acquire Firm B. The acquisition would result in incremental cash flows for Firm A of $10 million in each of the first five years. Firm A expects to divest Firm B at the end of the fifth year for $100 million. The ß for Firm A is 1.1, which is expected to remain unchanged after the acquisition. The risk-free rate, Rf , is 7 percent, and the expected market rate of return, Rm, is 15 percent.
Firm A is financed by 80 percent equity and 20 percent debt, and this leverage will also remain unchanged after the acquisition. Firm A pays interest of 10 percent on its debt, which will also remain unchanged after the acquisition.
a. Disregarding taxes, what is the maximum price that Firm A should pay for firm B?
b. Firm A has a stock price of $30 per share and 10 million shares outstanding. If Firm B shareholders are to be paid the maximum price determined in part (a) via a new stock issue, how many new shares will be issued, and what will be the postmerger stock price?