Cost Benefits of Merger

When Co. A acquires Co. B, than it is a capital investment

decision for A and a capital disinvestment decision for B.
I.Assuming Compensation is in cash

Net Present Value (NPV) for A = Benefit – Cost

Benefit = PVAB – [PVA + PVB]
Cost = Cash – PVB
NPVA= {PVAB – [PVA + PVB]} – [Cash – PVB]
Net Present Value (NPV) for B = Cost for A
= Cash – PVB

II Compensation is in stock

Ques: Firm A plans to acquire firm B. Following are the statistics

before the merger. The merger is expected to bring gains with PV of
Rs. 10 mn. Firm A offers 250,000 shares in exchange for Rs. 500,000
shares of B

A B
MPS Rs. 100 Rs. 40
No. of shares 10,00,000 5,00,000
MV of firm Rs. 100 mn Rs. 20 mn
The cost in this case is defined as Cost = [α * PVAB] – PVB

Where alpha (α) represents the fraction of shares received by B Ltd in

proportion to the total shares of the combined entity.

In the ques. Total shares of the combined entity = 10L + 2.5L

= 12.5L
Shares received by B = 2.5L
α = 2.5/12.5 = 0.2
PVAB = PVA + PVB + Gain = 100 + 20 + 10
= Rs. 130 mn
Cost = [α * PVAB] – PVB
= [0.2 * 130] – 20 = Rs. 6 mn
NPVA = Benefit – Cost = 10 – 6 = Rs. 4 mn
NPVB = Cost = Rs. 6 mn