 Merger valuation process is done by using net present value technique. If the settlement under a merger attempt is based on cash payment, then the technique works straightforwardly. But if the settlement for a merger attempt is through the issuance of stock, then the process becomes more difficult and complex. Let's see how these two techniques work differently. First, we have an example of cash settlement. We have two firms A and B, both are equity firm. A is acquiring firm B. We see that before acquisition, A has market value of $500 and B has market value of $100. So total market value of these two firms is $600. A has outstanding shares in the number of $25 where B has 10 shares outstanding. Price per share for A is $20 and for B it is $10. Now we assume the concept of the effect of synergy. So the combined value of these two firms using synergistic effect is $700. And if the consideration to settle in cash, it is $150 cash. So paying $150 out of synergistic value of the combined firm of $700, the remaining value rest with the firm A, B is equal to $550. The post merger rise in the A's share price is equal to $2. The net present value of this merger to the acquiring firm is equal to $50, which is the difference between the synergy value and the premium. But if we determine the average price of firm A using the value which it has remained after the payment of $150 cash to the acquired, it is $550. And taking this value to the market value, which is $500 and using these two figures with the probability of 60 and 40, we have a weighted average value of $530. If we use this value of $530 in the net present value, we will underestimate the value of the merger. So this means that determining value of a merger is a difficult subject. Now let's determine the value of common stock to determine the value of a merger. We have same data. We have firm A that is acquiring firm B, both are equity firms. Now the analysis may become difficult because we need to determine the number of shares to be issued to firm B. We have a data here and we assume that there is an exchange ratio of 0.75 into 1. That means that against one share of B, 0.75 shares of A will be issued to the stock orders of B. Now the cost to firm A will be equal to $20 per share multiplied by 7.5 shares and this comes to $150, although the value of stock settlement in this case is equal to the value of cash consideration in our previous example. But this is not a true cost of merger to the firm A. Now let's see that A's post merger outstanding shares come to 32.5 shares. Now the post merger holdings of B's share holders in the combined firm will be equal to 23% of 32.5 shares and if we determine the market value of B's holding in the combined firm it comes to $161 which is 23% of 700. Now this is in fact the true cost of merger to the stock holders of firm A. Now let's compare the share prices of firm A. Under cash buying share price is equal to $22 whereas under stock buying it comes to $21.54. So there is a reduction in the share price of the firm and that is $0.46. This is in fact the transaction cost to the stock holders of the firm in this merger. Now why this stock transaction cost is so high? Exchange ratio of 0.7521 is in fact based on the pre-merger prices of firms A and B. But A's share prices rise after the merger so B's stock holders will receive more than $150 in the firm A. A question arises that the word should be the exchange ratio so that B's stock holders should receive exactly the stock value equal to the amount of $150. To solve this let's assume alpha is B's stock holders holding in AB. So the post merger value of the B's share holders should be equal to the product of alpha and the market synergetic value of the combined firm which is $700. Setting alpha into $700 equal with the $150 the alpha value is equal to $21.43. This means that to equate the value of A's stock going to the pocket of B's share holders equal to the dollar value of $150. A needs to issue $21.43% of the combined firm's stock to the stock holders of B. By doing this AB's total outstanding shares now should be equal to $31.819 shares. Now the exchange ratio which we are determining new is equal to 0.6819 ratio 1. Now we determine again the A's share prices under both of the cases. Under stock buying it is equal to $22 using the new shares, total shares of the combined firm and under cash buying using the total shares of the combined firm it is equal to $22. Now at this stage we can see that the fair exchange ratio in this merger attempt is equal to 0.6819 ratio 1 because at this ratio the value of the stock going to the stock value of the A's stock going to the stock holders of B is exactly equal to the value of the cash buying which means that under both of the cases the value of the merger is equal to $150. So now when do bidders want to pay with the cash and when do they want to settle the merger consideration with stock? There is no easy and straight forward formula in fact this decision is most importantly links with the bidders on stock price. But there are certain implications for this stock settled transaction like acquirers managers may likely to have a different use than that of the market. And in that case they are more informed than does the market. So they may be believer of overvaluation of their stock and this may end up giving away less than the fair market value of the acquirers stock price. This might tip off the acquirers manager to think that the acquirer is overpriced. Alternatively the acquirer may demand a cash deal or the acquirer may choose not to deal this merger at all. Like acquirers learning from negotiations the market also learn there are empirical evidences that acquirers stock price generally falls upon the announcement of the stock transaction settlement. The conclusion from this discussion is that mistakes are likely to made in stock for stock transactions.