Question

Firm B is The Bidding Firm and Firm T is the Target Firm.Their financial data is as follows:

item	Firm B	Firm T
Total earning (E)	US $10 million	US $5 Million
Number of outstanding shares(s)	5 Million	5 Million
Earnings per share (EPS)	US$2	US$1
P/E ratio	6	4
Market Price per share (P)	US$12	US$4

(A) calculate the weighted average weighted average P/E for the combined Firm BT.

(B)Calculate the Maxium number of shares firm B will be willing to offer to the sockholders of firm T at the P/E calculated in Part (A) above.What will be the minimum number of shares acceptable to the stockholders of firm T at the same P/E level?

(C) If EPS was the criterion to determine the exchange ratio,how many shares firm B would offer to stockholders of firm T?in case,Market price per share was used as a basis to determine the exchange ratio,how much would your result change?which one do you think would be a better criterion for exchange rate determination?why?

Answer 1

A.Computing the combined P/E ratio of BT =P/E of B*(Earings of B)/(Earnings of BT)+P/E of T*(Earnings of T)/(Earnings of BT)

P/E(BT) = P/E(B)*E(B)/E(BT)+P/E(T)*E(T)/E(BT)

P/E(BT) = 6*$10millions/$15millions+4*$5million/$15million

= 4+1.33333

= 5.33

B.Calculating the maximum no. of shares that the B has to offer to T

a. MPS(B) = [ ?(B)+ ?(T)+ ??????? ????/ ?(B)+ ?(T)× ???????? ????? ?? ] × P/E (B+T)

$12 = [( $10+$5)/(5+5*a/b)]*5.1333

a/b=0.28332-(Exchange ratio)

Maximum no.of Shares to be offered = 5millions*0.28332

=50,00,000*0.28332

=14,16,600 Shares

b.Calculating the minimum no. of shares for T Firm

MPS(T) = [ [ ?(B)+ ?(T)+ ??????? ????/ ?(B)+ ?(T)× ???????? ????? ?? ]× P/E(A+B)× ER

$4 = [( $10+$5)/(5+5*a/b)]*5.1333*a/b

a/b=0.3509

Minimum no. of shares = 5millions*0.3509

= 50,00,000*0.3509

= 17,54,500 Shares

C.1.Based on the EPS the Exchange ratio is(ER)

ER = EPS of Target Firm/ EPS of Bidding Firm

ER = 1/2

ER is 0.5:1

No. of Shared to be Offered = Shares of the Target company *ER

No.of Shares to be Offered = 50,00,000*0.5

= 25,00,000 Shares to be Offered

2.Based on the MPS the Exchange ratio is(ER)

ER = MPS of Target Firm/MPS of Bidding Firm

ER = 4/12

ER is 0.3333:1

No. of Shared to be Offered = Shares of the Target company *ER

No.of Shares to be Offered = 50,00,000*0.3333

= 16,66,500 Shares to be Offered

Conclusion : Exchange ratio based on MPS is the better criteria because EPS(BT) Will increase by $0.25

1.Based on EPS-ER

EPS(BT) = 150,00,000/75,00,000= $2

2.Based on MPS-ER

EPS(BT) = 150,00,000/66,66,500= $2.25