Firm A seeks to acquire (privately owned) firm T whose ultimate dollar value is uncertain because of its possible liability for the past production of hazardous waste. The table shows A's and T's respective values (in $ millions) for the firm conditional on whether the firm is found to be liable. Note that A and T have different contingent values and different probability assessments (shown in parentheses) as to T's liability. Both firms are risk neutral.
Value of Firm T
|
A's Value
|
T Not Liable
50 (.5)
|
T Liable
20 (.5)
|
|
T's Value
|
40 (.8)
|
30 (.2)
|
a. Firm A is hoping to acquire T in a 100 percent cash transaction. Is a mutually beneficial 100 percent cash transaction possible? Explain.
b. Instead, suppose that firm A considers acquiring T, paying all or in part with its own stock. (The owners of T are prohibited from selling the stock they receive for two years.) If A acquires T and subsequently T is found liable, both sides expect that A's stock price will fall by 50 percent. Is a mutually beneficial 100 percent stock transaction possible? (Provide an example to show whether the answer is yes or no.)
c. The firms are considering a provision in the acquisition allowing T's senior managers (who will continue to work for the combined firm) to buy back (at a predetermined price) ownership of T in the event that the firm is found liable. Does such a provision make sense? Provide a qualitative explanation.