If investors believe a firm may be acquired, its market value is likely to be higher than its stand-alone value. Select one:
True
False
The correct answer and explanation is:
Correct Answer: True
When investors believe a firm may be acquired, its market value often increases above its stand-alone value. This phenomenon occurs because acquisition prospects typically imply that the acquiring firm sees added value in the target company, whether through synergies, cost savings, increased market share, or strategic advantages.
In a potential acquisition, the acquiring company usually offers a premium over the current market price to incentivize shareholders to sell their shares. This premium reflects the additional value the buyer expects to realize from the acquisition. For example, if the stock of a company is trading at $50 per share and rumors or announcements of a buyout surface, investors may anticipate an offer of $60 or more, prompting the share price to rise accordingly in anticipation of the deal.
Moreover, the market reacts quickly to any credible news about mergers or acquisitions. Investors begin to speculate that the target company is undervalued on a stand-alone basis and may soon benefit from improved profitability or efficiency under new ownership. This speculative behavior leads to increased demand for the company’s shares, which drives the price up.
This upward adjustment in the firm’s market value is not based on its current operations alone, but on expected future gains from being acquired. As a result, the market value in anticipation of acquisition exceeds the firm’s intrinsic or stand-alone value.
However, this increase can be reversed if the deal falls through or if regulatory or financial issues arise. Still, as a general principle, expectations of acquisition do tend to increase a firm’s market valuation, even before any formal offer is made.
Therefore, the statement is true because market expectations of acquisition lead to higher perceived value compared to the firm operating independently.