Question

Gamma plc has made an offer of one of its shares for every three of Baker plc. Synergistic benefits from the merger would result in an increase in after-tax earnings of 4 million € per annum. Extracts from the latest accounts of both companies are as follows:

	Gamma Plc	Baker Plc
Profit after tax, million €	120	35
Number of shares outstanding, million	400	90
Market price of shares, €	2.50	1.20

Assume that the price of Gamma Plc’s shares rises by 0.50 € after the merger and that Gamma issues new shares as consideration.

What will be the price-earnings ratio of the group?

Answer 1

	After Tax Earnings of merged entity
	= Profit after Tax of Gamma Plc + Profit After Tax of Baker Plc
	+ Increase due to Merger
	= €120000000 + €35000000 + €4000000
	= €159000000
	No of Shares issued to Baker Plc
	= No of Shares outstanding of Baker Plc * Swap Ratio
	= 90000000 * 1/3
	= 30000000
	Earnings Per Share of a merged entity
	= After Tax Earnings / (No of Shares outstanding of Gamma Plc + No of Shares issued to Baker Plc)
	= €159000000 / (400000000 + 30000000)
	= €159000000 / (430000000)
	= €0.37
	Market Price Per Share of Gamma Plc after merger
	= Current Market Price + Price Rise
	= €2.50 + €0.50
	= €3.00
	So,
	Price Earnings Ratio of Group
	= Market Price after merger / Earnings per Share after merger
	= €3 / €0.37
	= 8.11