Suppose you work as a strategic financial manager at Nadia Inc., a large telecommunications firm which is considering making an offer to purchase Shaan Inc. a smaller network company. You have collected the following information for this important financial decision:

Nadia Shaan

Price-earnings ratio 8 6

Shares outstanding 500,000 220,000

Earnings $1,500,000 $440,000

Securities analysts expect the earnings and dividends (currently $1 per share) of Shaan to grow at a constant rate of 4% each year. Nadia management believes that its acquisition of Shaan will generate some economies of scale increasing Shaan's dividend per share growth rate to 6% per year. Based on this belief, Nadia is considering the following two alternative ways of acquiring Shaan:

Alternative 1

Acquire Shaan by paying $15 cash per share for Shaan's stock.

Alternative 2

Acquire Shaan by share exchange ratio of l:4 (i.e. one share of Nadia for 4 shares of Shaan).

Required

a. Which of the above two alternatives Should Nadia choose? Support your answer with calculations.

b. At what exchange ratio of Nadia's shares to Shaan's shares would the shareholders of Shaan be indifferent between Nadia's cash or stock offer for their stock? Show calculations to support your answer.