Understanding Firm Acquisition Cost

This question asks us to calculate the apparent cost for Firm A to acquire Firm B through a share exchange. In a stock-for-stock acquisition, the acquiring firm (Firm A) issues new shares to the shareholders of the target firm (Firm B) in exchange for their shares.

The "apparent cost" in such a scenario often refers to the premium paid by the acquiring firm over the target firm's pre-merger market value. Let's break down the financial details provided for both firms.

Financial Details of Firm A and Firm B

We are also told that the merger is expected to bring gains with a present value of Rs. 10 million, and Firm A offers one share for every two shares of Firm B.

Calculating the Apparent Cost of Acquisition

The apparent cost is calculated based on the value of the shares Firm A gives up to acquire Firm B and the pre-merger market value of Firm B. Here's the step-by-step calculation:

Step 1: Determine the Number of Shares Issued by Firm A

Firm A offers one of its shares for every two shares of Firm B. Firm B has 500,000 shares outstanding. We need to find out how many shares Firm A needs to issue to exchange with all of Firm B's shares.

The exchange ratio is \( \frac{1 \text{ share of A}}{2 \text{ shares of B}} \).

The number of shares Firm A will issue is:

\( \text{Number of shares issued by A} = \text{Number of Firm B shares} \times \text{Exchange Ratio} \)

\( \text{Number of shares issued by A} = 500,000 \text{ shares} \times \frac{1}{2} = 250,000 \text{ shares} \)

So, Firm A will issue 250,000 new shares to the shareholders of Firm B.

Step 2: Calculate the Total Market Value of Shares Issued by Firm A

The value of the consideration given by Firm A is the market value of the shares it issues. The market price of Firm A's shares is Rs. 50 per share.

The total market value of the shares issued by Firm A is:

\( \text{Value of shares issued by A} = \text{Number of shares issued by A} \times \text{Market Price of Firm A shares} \)

\( \text{Value of shares issued by A} = 250,000 \text{ shares} \times \text{Rs. } 50/\text{share} = \text{Rs. } 12,500,000 \)

This Rs. 12,500,000 is the total value Firm A is effectively paying using its own shares.

Step 3: Calculate the Apparent Cost (Premium Paid)

The apparent cost in this context can be interpreted as the premium paid by Firm A over the pre-merger market value of Firm B. Firm B's market value before the merger was Rs. 10 million.

The apparent cost (premium) is the difference between the value of the shares issued by Firm A and the original market value of Firm B.

\( \text{Apparent Cost} = \text{Value of shares issued by A} - \text{Market Value of Firm B} \)

\( \text{Apparent Cost} = \text{Rs. } 12,500,000 - \text{Rs. } 10,000,000 \)

\( \text{Apparent Cost} = \text{Rs. } 2,500,000 \)

This represents the premium Firm A is paying to acquire Firm B's shares compared to their market value before the acquisition announcement based on the given exchange ratio and Firm A's share price.

The merger gains of Rs. 10 million are a separate benefit from the merger and are not directly used in calculating this specific apparent cost (premium paid).

Final Apparent Acquisition Cost

Based on the calculations, the apparent cost of acquiring Firm B, interpreted as the premium paid through the share exchange, is Rs. 2,500,000.

Revision Table: Key Acquisition Concepts

Understanding the terms involved in acquisition calculations is crucial.

Additional Information: Merger & Acquisition Costs

The cost of an acquisition can be viewed in several ways. The apparent cost, as calculated here, often focuses on the premium paid over the target's pre-acquisition market value when using stock as consideration. This premium is the extra value received by the target shareholders compared to holding their original shares.

Another way to look at cost is the total consideration paid (Rs. 12.5 million in this case). This is the direct value of the assets (Firm A's shares) given up by the acquiring firm.

The true economic cost or benefit of an acquisition is more complex and considers the synergy or gains created by the merger. The net cost of the merger could be considered the total consideration minus the value of the target firm plus any acquisition costs and minus the value of the synergy/gains. However, this question specifically asks for the "apparent cost," which aligns with the premium calculation based on the options provided.