Question

The shareholders of Bread Company have voted in favor of a buyout offer from Butter Corporation. Information about each firm is given here:

	Bread			Butter
Price-earnings ratio		6.35			12.7
Shares outstanding		73,000			146,000
Earnings	$	230,000		$	690,000

Bread’s shareholders will receive one share of Butter stock for every three shares they hold in Bread.

a-1	What will the EPS of Butter be after the merger? (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)

a-2	What will the PE ratio be if the NPV of the acquisition is zero? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b.	What must Butter feel is the value of the synergy between these two firms?

    

Answer 1

a-1). EPS = Sum of the earnings of both companies / Shares in the combined company

= [$230,000 + $690,000] / [146,000 + {(1/3) * 73,000}]

= $920,000 / 170,333.33 = $5.401

a-2). The market price will remain unchanged if its' a zero NPV acquisition

So, P = (Price-earnings ratio x Earnings of Butter Corporation) / Shares outstanding of Butter Corporation

= [12.7 * $690,000] / 146,000 = $60.02

New P/E = Price per share / EPS = $60.02 / $5.401 = 11.11

b). Cost of the acquisition = Number of shares offered x Share price

= (1/3 x 73,000) x $60.02 = $1,460,500

V* = Earnings of Bread Company x Price-earnings ratio of Bread Company

= $230,000 x 6.35 = $1,460,500

The value of Bread to Butter must be the market value of the company since the NPV of the acquisition is zero.

NPV of the acquisition = 0 = V* + V - Cost

$0 = $1,460,500 + V - $1,460,500

V = $0

Although there is no economic value to the takeover, it is possible that Butter is motivated to purchase Bread for other than financial reasons.