Calculator
The announced acquisition price in cash per share.
Where the target stock trades right now.
Calendar days from today to expected deal close.
Where you estimate the stock trades if the deal fails.
Your own estimate of the deal closing. Used for expected return only.
Brokerage commissions + spread as % of position. Optional.
Gross spread
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Annualized return (if deal closes)
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Gross, before transaction costs
Annualized return (net of costs)
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After round-trip transaction costs
Loss if deal breaks
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Break-even deal probability
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Market-implied minimum success rate
Expected return (your estimate)
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Probability-weighted outcome
How to Use This Calculator
Enter the announced offer price — the per-share cash consideration stated in the merger agreement or tender offer — and the current market price of the target stock. The gap between these two numbers is the gross spread: the absolute per-share gain if the deal closes at the stated terms. Enter the number of calendar days from today to the expected close date to convert the gross spread into an annualized return. For a deal expected to close in 90 days, the annualized return is approximately 4× the gross return.
The break price is the most important and most uncertain input. Estimate where you believe the target stock would trade if the deal fails. Consider the stock's pre-announcement trading level, whether fundamental investors would still support it at that price, and whether the announcement itself revealed negative information about the company that would depress its standalone value. A realistic break price estimate — not necessarily the pre-announcement price — is essential for the break-even probability and expected return calculations.
Enter your own deal success probability estimate to compute the probability-weighted expected return. If your estimate exceeds the break-even probability, the investment has positive expected value at current spread levels. If it is below the break-even probability, the spread does not adequately compensate for the risk you perceive. Transaction costs reduce the annualized return on what is already a thin-margin strategy — include them to see the realistic net return.
Understanding the Outputs
The gross spread is the absolute dollar gain per share and the percentage return on capital deployed if the deal closes at exactly the stated offer price. It is the raw "upside" of the position. Gross spreads typically range from 1–8% on announced friendly deals, with wider spreads reflecting higher regulatory risk, longer timelines, or lower market confidence in deal completion.
The annualized return assuming deal close converts the gross spread into an annualized figure by multiplying by (365 / days to close). This is the correct metric for comparing merger arb positions with different expected timelines — a 3% gross spread on a 60-day deal (18.25% annualized) is more attractive than a 3% spread on a 180-day deal (6.08% annualized), assuming similar break risk. Compare annualized returns to your cost of capital or alternative investment returns.
The break-even deal probability is derived from the formula: L / (G + L), where L is the loss if the deal breaks and G is the gain if it closes. This is the minimum deal success rate at which the position has zero expected return. If the market's implied probability (shown here) exceeds your own estimate, the current spread does not adequately compensate you for deal break risk. If the market's implied probability is below your estimate, there may be positive expected value.
The expected return using your estimate is the probability-weighted average outcome: (your deal probability × gain) minus (break probability × loss). A positive expected return does not guarantee profit — individual outcomes are binary (deal closes or breaks). But across many investments with positive expected return, the strategy should generate positive average returns over time.
Assumptions and Limitations
- Cash deals only: This calculator models pure cash acquisition deals. Stock-for-stock deals require a separate analysis incorporating the acquirer's share price and exchange ratio dynamics, and require the acquirer short position to be modeled as a hedge.
- Binary outcome model: The calculator assumes two outcomes — deal closes at the stated price, or deal breaks and the stock trades to the estimated break price. In reality, deals can be renegotiated (lower price), extended (compressed annualized return), or receive competing bids (price above offer). These scenarios are not modeled.
- Break price is an estimate: The break price is the most important uncertain input, and no formula can determine it. The calculator uses your estimate; a range of break prices should be tested to understand sensitivity.
- No financing cost: If the position is financed with margin, the borrowing cost reduces the net return and is not included in the calculator. Subtract margin interest from the annualized return for a leveraged position.
- Transaction costs are round-trip: The transaction cost input should include the full round-trip cost — buying the target plus selling at close (either to the acquirer in a tender or in the market post-close in a merger). For liquid large-cap targets, this is typically 0.05–0.15%. For illiquid small-caps, this can be 0.5–2%.
Frequently Asked Questions
Why does the target stock trade below the offer price?
The spread compensates investors for three risks: time value (capital is locked until close with no return unless the stock moves); break risk (the deal might fail, causing the stock to fall sharply); and regulatory/execution risk (the deal might close later than expected, reducing annualized return). In an efficient market, the spread should equal the probability-weighted cost of these risks. When the spread is wider than this equilibrium, there may be excess compensation for the risk — the "opportunity" in merger arbitrage.
What is a typical annualized merger arb return?
Historically, a diversified portfolio of merger arbitrage positions has generated annualized gross returns of approximately 6–12% before leverage and transaction costs. After costs and leverage, net returns have typically been 4–8% depending on the strategy and period. These returns are low in absolute terms but have historically exhibited low correlation to equity market returns, making merger arb attractive as a component of a diversified hedge fund or alternative strategy portfolio. Individual positions can generate much higher or lower annualized returns depending on deal timeline and spread.
How do I estimate the break price?
Start with the pre-announcement "undisturbed" price — the stock's trading level in the 20–30 days before any announcement or speculation. Ask: has the company's fundamental situation changed since the announcement? If so, adjust the break price. If the company revealed operational weakness in the deal proxy materials, the break price may be lower than the pre-announcement level. If the announcement revealed positive information about the company's intrinsic value, the break price may be somewhat above the pre-announcement level. Building a range — optimistic, base, and pessimistic break scenarios — and averaging them probability-weighted produces a better estimate than a single point.
Should I use the deal close date or the regulatory approval date?
Use the expected deal close date — the date by which you believe the definitive merger agreement conditions will be satisfied and the transaction will actually close. For deals with minimal regulatory concern, this is close to the shareholder vote date (typically 3–4 months post-announcement). For deals facing regulatory review, build in the expected review timeline. If a second antitrust request is issued, update the expected close date accordingly and recompute the annualized return. The annualized return falls as the timeline extends, which is why regulatory delays reduce the attractiveness of a position even if the ultimate outcome is unchanged.
What does it mean if the break-even probability is 95%?
A break-even probability of 95% means the current spread only compensates you if the deal succeeds at least 95% of the time — there is almost no margin for error. If you believe the deal has, say, an 85% probability of success, the current spread is too narrow for the risk you perceive: you would expect to lose money on average at that probability. Very tight spreads (high break-even probabilities) are common late in deal cycles, near expected close dates, when deal risk has been substantially resolved. Early in a deal's life, break-even probabilities tend to be lower, reflecting genuine uncertainty. A break-even probability below 80% suggests the market is pricing in meaningful deal risk.
Sources
Disclaimer
This calculator is for educational purposes only and does not constitute investment advice. Merger arbitrage involves significant risk including the loss of the entire position if a deal fails. Inputs and outputs are illustrative estimates; actual returns depend on outcomes that cannot be predicted. Do not make investment decisions based solely on this calculator. Consult a qualified financial professional.