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Tender offer by the firms and fair value premium over market

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If ABC Co. makes a tender offer and will not exeed 20% premium, how do you calculate fair value premium over market.

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Solution Summary

The solutions provides the rational for the premium over market in the tender offers by the firms and then discuss how we can work out the fair premium over market. It discusses the dividend discount model for valuation and how investments in new projects change the future dividends and stock price. It then provides the formula for calculating the fair value premium.

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1. The current value of stock represents the present value of expected future dividends. Companies generally do not pay all its EPS as dividend. Some part of EPS is retained for investment in new projects. The assumption behind the investment of retained earnings is that it should give an ROE, which is either equal to the current ROE or more than the current ROE.

2. The fresh tender offers are generally made by companied to start new projects. ...

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