Chicago Savings Corporation is planning to make an offer for Erie's Bank and Trust. The stock for Erie's Trust is currently selling for $50 per share.
a. If the tender offer is planned at a premium of 40% over market price, what will be the value offered per share for Erie's?
b. Suppose before the offer is announced, the stock price of Erie's goes to $60 because of strong merger rumors. If you buy the stock at that price and the merger goes through (at the price calculated in a), what will your % gain be?
c. Because there is always the possibility that the merger could be called off after it is announced, you also want to consider your % loss if that happens. Assume you buy the stock at $60 and it falls back to its original value after the merger cancellation. What will your % loss be?
d. There is a 70% probability that the merger will go through when you buy the stock at $60 and only a 30% chance that it will be called off.
i. Compute the expected value of the return on the investment. Assume the time period involved is short.
ii. Does this appear to be a good investment?