Question

M&A EPS Illusion

This question illustrates what is known as the M&A earnings-per-share illusion: an M&A deal has the ability to boost a firm's EPS. This effect was highly exploited over the 2nd-M&A wave to lure those dealmakers who were assessing M&A deals' success based on EPS.

Information

Your company has EPS of 1, 1 million of shares outstanding and a price per share of $25. You are thinking of buying T Corporation (T Co.), which has EPS of 1, 0.1 million of shares outstanding and a price per share of $10. You will pay for T Co. by issuing new shares of your company. Assume that there are no expected synergies from this takeover and you will pay a 40% premium (pi=1.4).

Use this information to complete the following calculations that yield the "new EPS" of your company after the takeover. Express your answers using 3 decimal places.

• To buy T Co.,________ million new shares will have to be issued.
• After the takeover, your firm will have:
  • __________million shares outstanding.
  • $_________million. of total earnings.
  • An EPS ratio equals to_________.

Verify that the post-takeover EPS is larger than the pre-takeover EPS of your company.

Answer 1

From the question, we know the following:

Present shares outstanding for company = 1 million

EPS for company = 1

Current price of share of company = $25

Shares outstanding of T Co. = 0.1 million

EPS of T Co. = 1

Share price of T Co. = $10

We also know that:

Total earnings = No. of shares outstanding * EPS

So, total earnings of company = 1 million * 1 = $ 1 million

Total earnings of T Co. = 0.1 million * 1 = $ 0.1 million

Now, to calculate total number of new shares to be issued:

Value of total shares of T Co. = Shares outstanding * Price per share

Value of T Co. = 0.1 million * 10 = $ 1 million

Total premium to be paid = 40%

Total value to be paid by company to T Co. = $ 1 million * 1.4 = $ 1.4 million

Total new shares to be issued = Value to be paid / Market price per share

= 1.4 million / 25 = 0.056 million

Total number of shares outstanding after takeover = 1 million + 0.056 million = 1.056 million

Total earning after takeover = total earnings of company + total earnings of T Co.

= 1 million + 0.1 million = $ 1.1 million

EPS after takeover = Total earnings / Total shares outstanding

= 1.1 / 1.056 = 1.042

All answers are:

a. 0.056 million new shares

b. 1.056 million shares outstanding

c. 1.1 million total earnings

d. EPS of 1.042

Since of EPS of 1.042 is higher 1, we can verify that EPS post takeover is larger than EPS pre takeover.