In: Finance
Kyle's company has earnings per share of $8. It has 1 million shares? outstanding, each of which has a price of $24. Kyle is thinking of buying? TargetCo, which has earnings per share of $4?, 1 million shares? outstanding, and a price per share of $21. Kyle will pay for TargetCo by issuing new shares. There are no expected synergies from the transaction. Complete parts? (a) through? (d) below.
a. If Kyle pays no premium to buy? TargetCo, what will his earnings per share be after the? merger?
b. suppose Kyle offers an exchange ratio such that, at current pre-announcement share prices for both firms, the pffer represents a 20% premiuum to but TargetCo. what will kyleès earnings per share be after the merger?
c. what explains the change in earnings per share in part a? are Kyle's shareholders any better or worse off?
d. what will Kyle's price-earnings (P/E) ratio be after the merger (if Kyle pays no premium)? how does this compare to Kyle's (P/E)ratio before the merger? How does this compare to TargetCo's pre-merger (P/E) ratio?
Solution:-
a) If no premium is paid :-
Total earnings =Earning of Kyle+ Earning of Target
= ($8*1million)+(($4*1million ) = 12 Million
Number of share to be issued to target company
=(share price of target co/Share price of kyle)*NO of shares of target co
=( 21/24)*1million= 875,000 shares.
Total number of shares = Existing +New issued= 1,000,000+875,000
=1,875,000 shares
Post merger EPS= Post merger total earning/ Post merger total number of shares
= 12,000,000/1,875,000
= $6.4
b) At 20% premium
The exchange rate will be = 21*(1+premium)/24 = 21*1.20/24= 1.05
Hence the number of shares issued to target company
= 1,000,000*1.05=1,050,000 shares
Total number shares = existing +new = 2,050,000 shares
EPS = 12,000,000/2,050,000= $5.85
c) The EPS in part (a) is lower than Kyle's but higher than target co. The change in EPS is due to merger with the company with different PE ratio. Simply by looking the EPS changes we cannot say for sure whether the shareholder are better off or worse.
d) The total market capitalization of the both company
= $24*1 million+$21*1 million =$45 million
Total earnings of both companies were
= $8*1million+$4*1millon =$12 million
The PE ratio merger after = Total market value/ total earning
=45/12= 3.75 times
The PE ratio of Kyle's before merger = MPS/EPS= 24/8= 3 times
The PE ratio of target co before merger = 21/4= 5.25 times
Therefore, the PE ratio of the merged firm is higher than Kyle's but lower than Target’s before the merger
Please feel free to ask if you have any query in the comment section.