Advanced Financial Management · Mergers, Acquisitions and Corporate Restructuring

Financing the Deal: Cash vs Stock Offer (CA Final AFM)

Updated 5 October 2026 · Fact-checked

Financing the deal means choosing between paying target shareholders cash or giving them shares of the combined firm. Find synergy first: combined value minus the two standalone values. Under cash, cost is cash paid minus target's standalone value. Under stock, cost is target's share of combined value minus standalone value. NPV to acquirer is synergy minus cost.

Understand Financing the Deal: Cash vs Stock Offer

A merger creates value only if the combined firm is worth more than the two firms standing alone. That extra value is the synergy (also called the benefit of the merger). The acquirer then has to share some of it with the target shareholders to win their consent. How much it shares depends on how it pays.

In a cash offer, target shareholders get a fixed amount and leave. They do not share in the future of the combined firm. Their gain is the premium: cash received minus the target's standalone value. All remaining synergy belongs to the acquirer's shareholders. The cost to the acquirer is fixed, whatever the synergy turns out to be.

In a stock offer, target shareholders get shares of the acquirer and become part owners of the combined firm. They receive a fraction of the combined value. So their gain moves up and down with the synergy, and they share the risk that the synergy never arrives. The cost to the acquirer is therefore not fixed. It is that fraction of combined value minus the target's standalone value.

In both cases, gain to acquirer shareholders + gain to target shareholders = synergy. This is your check. If your two gains do not add up to the synergy, something in your working is wrong.

The usual exam question gives standalone values, a combined value or the synergy, and one or two offers. You compute the NPV to the acquirer and the gain to the target under each offer, and then say which offer is better for whom.

Key rules to remember

Benefit (synergy) of merger: Benefit = PV of combined firm (A+B) − (PV of A + PV of B); PV means standalone or combined value of the firm. Use market value if given, otherwise the DCF or P/E value the question supplies.
Cost of merger: cash offer: Cost = Cash paid − PV of B; This equals the premium paid to B's shareholders. It does not depend on the synergy.
Cost of merger: stock offer: Cost = x × PV of combined firm − PV of B; x is B's share of the combined firm, which equals new shares issued to B ÷ (A's old shares + new shares issued).
NPV to acquirer: NPV to A = Benefit − Cost; Accept the merger if NPV to A is positive. Equivalent check: value of A's holding after the deal − PV of A.
Gain to target shareholders: Gain to B = Cost (as defined above) = Value received − PV of B; Under cash this is the premium. Under stock the value received is x × combined value.
Value to acquirer shareholders: Cash: PV of combined − Cash paid. Stock: (1 − x) × PV of combined; Subtract PV of A to get the NPV to A. Divide by A's shares for the value per share.
Break-even limits: Max cash price = PV of B + Benefit. Max stock share x = (PV of combined − PV of A) ÷ PV of combined; Beyond these limits, NPV to the acquirer turns negative.

How to solve Financing the Deal: Cash vs Stock Offer questions

Use the same sequence for every cash-versus-stock question. Write each figure on its own line so you earn method marks even if one number slips.

1List the standalone values of A and B, and the value of the combined firm. If only synergy is given, add it to the sum of the standalone values to get the combined value.
2Compute the benefit: combined value − (PV of A + PV of B).
3For a cash offer, compute total cash paid (price per share × target shares). Cost = cash paid − PV of B.
4For a stock offer, compute new shares issued from the exchange ratio. Then x = new shares ÷ (A's old shares + new shares). Cost = x × combined value − PV of B. Value the stock offer this way, not at new shares × A's current price, because A's share price changes after the merger.
5Compute NPV to A = benefit − cost for each offer.
6Compute gain to B shareholders = cost for each offer, and confirm that gain to A + gain to B = benefit.
7If asked, compute post-merger value per share for A's shareholders and compare the offers.
8Conclude: name the offer that gives A the higher NPV, and state what B gains under each. Mention that stock shares the synergy risk and cash does not.

Quickest way: Three-line shortcut: synergy, split, check

When to use it: Use when the question gives or lets you derive standalone and combined values quickly, and you are short of time.

Line 1: Synergy S = combined − (A + B).
Line 2: Gain to B. Cash: price paid − PV of B. Stock: x × combined − PV of B.
Line 3: NPV to A = S − gain to B. Check against (1 − x) × combined − PV of A for stock, or combined − cash − PV of A for cash.
The gain to B under stock is higher than under cash exactly when x × combined is higher than the cash price. Compare those two numbers directly instead of redoing everything.
Stock is cheaper for A only when x × combined value is below the cash price. For a fixed x, that happens when combined value is below cash price ÷ x. In terms of synergy, it means synergy is below (cash price ÷ x) − (PV of A + PV of B). In the Alpha example this threshold is 5 ÷ 0.2 − 24 = ₹1 crore.

Common mistakes in Financing the Deal: Cash vs Stock Offer

Using the offer price as the cost without deducting the target's standalone value.
Students treat the amount paid as the cost, forgetting that B's shareholders already own value worth PV of B.
Fix: Always write Cost = value given to B − PV of B. The cost is the premium, not the price.
Calculating the stock-offer cost with B's standalone value or old EPS-based share instead of B's share of the combined firm.
The cash formula is applied to the stock case by habit.
Fix: For stock, first find x from new shares ÷ total shares after the deal, then multiply x by the combined value.
Computing x as new shares ÷ A's old shares.
Students divide by A's existing shares and forget the new shares also form part of the post-merger share count.
Fix: Write x = new shares ÷ (old shares of A + new shares). For example, 5 lakh ÷ 25 lakh, not 5 lakh ÷ 20 lakh.
Deducting the cash paid from the combined value twice, or not at all, when finding value to A's shareholders.
Confusion over whether the given combined value is before or after the cash outflow.
Fix: Treat the combined value as before the payment. A's holders get combined value − cash paid. Then check that the NPV equals benefit − cost.
Not checking that the gains add up to the synergy.
Students stop after getting two numbers and never test them.
Fix: Add gain to A and gain to B. If the total is not the benefit, recheck x and the combined value.
Declaring the stock offer better simply because no cash goes out.
Cash conservation feels like a gain.
Fix: Compare NPV to A under both offers. Stock is cheaper for A only when x × combined value is below the cash price. For a fixed x, that means synergy below the break-even level (cash price ÷ x − sum of standalone values). Above that level, stock costs A more than cash.

Worked examples

Example 1

Alpha Ltd has 20 lakh shares at ₹100 each (market value ₹20 crore). Beta Ltd has 10 lakh shares at ₹40 each (₹4 crore). Alpha expects synergy worth ₹2 crore, so the combined firm is worth ₹26 crore. Alpha offers either (a) ₹50 cash per Beta share, or (b) 1 Alpha share for every 2 Beta shares. Find the NPV to Alpha and the gain to Beta shareholders under each offer, and say which offer Alpha should prefer.

Show the solution

Benefit = 26 − (20 + 4) = ₹2 crore.
Cash offer: cash paid = 10 lakh × ₹50 = ₹5 crore. Cost = 5 − 4 = ₹1 crore.
NPV to Alpha = 2 − 1 = ₹1 crore. Gain to Beta = ₹1 crore.
Check: Alpha holders get 26 − 5 = ₹21 crore, which is ₹1 crore above ₹20 crore. Value per Alpha share = 21 crore ÷ 20 lakh = ₹105.
Stock offer: new shares = 10 lakh ÷ 2 = 5 lakh. x = 5 ÷ (20 + 5) = 0.20.
Do not value the offer at 5 lakh × ₹100 = ₹5 crore. That uses Alpha's pre-merger price. After the merger Alpha's share price becomes ₹104, so the offer is worth x × combined value = 0.20 × 26 = ₹5.2 crore. Check: 5 lakh × ₹104 = ₹5.2 crore.
Cost = 5.2 − 4 = ₹1.2 crore, so gain to Beta = ₹1.2 crore.
NPV to Alpha = 2 − 1.2 = ₹0.8 crore.
Check: Alpha holders keep 0.80 × 26 = ₹20.8 crore, which is ₹0.8 crore above ₹20 crore. Value per share = 20.8 crore ÷ 20 lakh = ₹104.
Total gains: cash 1 + 1 = 2; stock 0.8 + 1.2 = 2. Both equal the synergy.
Why stock is dearer here: break-even combined value is 5 ÷ 0.2 = ₹25 crore, which means synergy of ₹1 crore. Actual synergy is ₹2 crore, above that, so x × combined (₹5.2 crore) exceeds the cash price (₹5 crore).

Answer: Cash offer: NPV to Alpha ₹1 crore, gain to Beta ₹1 crore. Stock offer (valued at 0.20 × ₹26 crore = ₹5.2 crore): NPV to Alpha ₹0.8 crore, gain to Beta ₹1.2 crore. Alpha should prefer the cash offer, since it keeps a larger share of the synergy.

Example 2

Gamma Ltd is worth ₹500 crore and Delta Ltd is worth ₹100 crore. The merged firm is expected to be worth ₹650 crore. Delta's shareholders will accept either ₹120 crore in cash or 20% of the combined firm. (a) Compute NPV to Gamma and gain to Delta under each. (b) What is the maximum cash price and the maximum share of the combined firm Gamma can offer without a negative NPV?

Show the solution

Benefit = 650 − (500 + 100) = ₹50 crore.
Cash: cost = 120 − 100 = ₹20 crore. NPV to Gamma = 50 − 20 = ₹30 crore. Gain to Delta = ₹20 crore.
Check: Gamma holders get 650 − 120 = ₹530 crore, which is ₹30 crore above ₹500 crore.
Stock: value to Delta = 0.20 × 650 = ₹130 crore. Cost = 130 − 100 = ₹30 crore. Gain to Delta = ₹30 crore.
NPV to Gamma = 50 − 30 = ₹20 crore.
Check: Gamma holders keep 0.80 × 650 = ₹520 crore, which is ₹20 crore above ₹500 crore.
Maximum cash price: NPV to Gamma is zero when cost equals benefit. Max cash = 100 + 50 = ₹150 crore.
Maximum share: Gamma's holders must keep at least ₹500 crore. (1 − x) × 650 ≥ 500, so x ≤ 150 ÷ 650 = 0.2308, about 23.08%.

Answer: Cash: NPV to Gamma ₹30 crore, gain to Delta ₹20 crore. Stock (20%): NPV to Gamma ₹20 crore, gain to Delta ₹30 crore. Gamma can pay up to ₹150 crore in cash or up to about 23.08% of the combined firm before its NPV turns negative.

Exam tips

Write the benefit, cost and NPV as separate labelled lines. Marks are given for each step even if the final number is off.
Always show the exchange ratio working: new shares issued, total shares, and then x. Examiners look for this line.
State your conclusion in a sentence: which offer is better for the acquirer, and which for the target. A table of numbers without a conclusion loses marks.
In case-scenario MCQs, use the check that gain to A plus gain to B equals the synergy to eliminate wrong options fast.
If the question gives post-merger EPS or P/E data, use it to find the combined value, then apply this framework. See the exchange ratio topic for the EPS route.

Practice questions from Mergers, Acquisitions and Corporate Restructuring

Financing the Deal: Cash vs Stock Offer: frequently asked questions

How do I calculate NPV of a merger with a cash offer?

Find the synergy as combined value minus the sum of standalone values. Then subtract the premium, which is cash paid minus the target's standalone value. The result is the NPV to the acquirer's shareholders.

Why does the cost of a stock offer depend on the synergy?

Target shareholders receive a fraction of the combined firm. If synergy rises, the combined value rises and so does the value of their fraction. In a cash offer the amount is fixed, so synergy gains stay with the acquirer.

Is the gain to target shareholders the same as the cost to the acquirer?

Yes, in this framework. The cost of the merger is the value the target shareholders receive minus their standalone value, which is exactly their gain. The acquirer's NPV is the synergy minus that gain.

When is a stock offer better than cash for the acquirer?

The stock offer is cheaper for A only when x × combined value is below the cash price. For a fixed x, that happens when synergy is below the break-even level, which is cash price ÷ x minus the sum of standalone values. In the Alpha example, break-even combined value is 5 ÷ 0.2 = ₹25 crore, so synergy below ₹1 crore. Actual synergy was ₹2 crore, so stock was dearer.