Cash versus Common Stock

Whether to finance an acquisition by cash or by shares of stock is an important decision. The choice depends on several factors, as follows:

1. Overvaluation. If in the opinion of management the acquiring firm's stock is overvalued, using shares of stock can be less costly than using cash.

2. Taxes. Acquisition by cash usually results in a taxable transaction. Acquisition by exchanging stock is tax free.

3. Sharing Gains. If cash is used to finance an acquisition, the selling firm's shareholders receive a fixed price. In the event of a hugely successful merger, they will not participate in any additional gains. Of course, if the acquisition is not a success, the losses will not be shared and shareholders of the acquiring firm will be worse off than if stock were used.

Question h r"----• In an efficient market with no tax effects, should an acquiring firm use cash or stock?

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