Calculation of Exchange Ratio from the perspective of the acquired and the acquiring firm

Whenever a firm A acquires another firm B, the compensation to the shareholders of the acquired firm is usually paid in the form of shares of the acquiring firm. In other words, shares of firm A will be given in exchange for shares of firm B. Thus, the exchange ratio is a very important factor in any kind of merger. Firm A will want to keep this ratio as low as possible, while firm B will want it to be as high as possible. In any case, both firms would ensure that post merger, their equivalent price per share will at least equal their pre-merger price per share. Given below is the model developed by Conn and Nielson for determining the exchange ratio. The symbols used in this model are: ER = Exchange ratio P = Price per share EPS = Earning per share PE = Price earning multiple E = Earnings S = Number of outstanding equity shares AER = Actual exchange ratio In addition, the acquiring, acquired and combined firms will be referred to by subscripts A, B and AB respectively. Firm A would ensure that the wealth of its shareholders is preserved. This implies that the price per share of the combined firm is at least equal to the price per share of firm A before merger: PAB >= PA For the sake of simplicity consider that P AB =P A Price earnings ratio of the combined firm x Earnings per share of the combined firm gives the Market Price per share. P AB =PE AB x EPS AB = P A ------- (1) Earnings per share of the combined firm can be expressed as: EPS AB = (E A + EB ) / [S A + S B (ER A )] ------- (2) ER A = number of shares of firm A given in lieu of one share of firm B. Substituting formula of EPS AB in equation 1 we get P A = PE AB (E A +EB)/[S A +S B (ER)] From the above equation, we may solve for the value of ER A as follows

ER A = -(S A /S B ) + [(E A +E B) PE AB] / P A S B After discussing the maximum exchange ratio acceptable to the shareholders of firm A above, we will now calculate the minimum exchange ratio acceptable to the firm B(ER B) The basic condition is P AB (ER B) >= P B ---------- (3) Using the equality form of above equation and substituting P AB from equation 1 in equation 3 we get PE AB x EPS AB x ER B = P B Substituting the value of EPS AB from equation 2 in the above equation, and solving the equation for ER B we get ER B = P B S A / [(PE AB)(E A + E B) P B S B]

Exchange Ratio The number of new shares in an acquiring firm that are given for each outstanding share of an acquired firm. Exchange Ratio In mergers and acquisitions, the number of shares an acquiring firm distributes for each validly rendered share of the acquired company. Each exchange ratio is calculated in accordance to the merger or acquisition agreement. Factors considered in determining the ratio are the relative value of each company prior to the closing of the merger or acquisition, any potential tax advantages for both parties, and applicable regulations. Exchange Ratio In mergers and acquisitions, the number of shares an acquiring firm distributes for each validly rendered share of the acquired company. Each exchange ratio is calculated in accordance to the merger or acquisition agreement. Factors considered in determining the ratio are the relative value of each company prior to the closing of the merger or acquisition, any potential tax advantages for both parties, and applicable regulations.