Question

Consider the following premerger information about Firm A and Firm B:

	Firm A			Firm B
Total earnings	$	2,700		$	900
Shares outstanding		1,000			200
Price per share	$	29		$	33

Assume that Firm A acquires Firm B via an exchange of stock at a price of $35 for each share of B's stock. Both A and B have no debt outstanding.

a.	What will the earnings per share, EPS, of Firm A be after the merger? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

EPS

$

b.	What will Firm A's price per share be after the merger if the market incorrectly analyzes this reported earnings growth (that is, the price–earnings ratio does not change)? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Price per share

$

c.	What will the price–earnings ratio of the postmerger firm be if the market correctly analyzes the transaction? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

PE ratio

times

d-1.	If there are no synergy gains, what will the share price of A be after the merger? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Price per share

$

d-2.	What will the price–earnings ratio be? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

PE ratio

times

d-3.	What does your answer for the share price tell you about the amount A bid for B? Was it too high? Too low?
	Too high Too low

Answer 1

Solution :-

The cost of the acquisition is:

Cost = 200 * ( $35 ) = $7,000

Since the stock price of the acquiring firm is $29, the firm will have to give up:

Shares offered = $7,000 / $29 = 241.38 shares

(A)

The EPS of the merged firm will be the combined EPS of the existing firms divided by the new shares outstanding, so:

EPS = ( $2,700 + 900 ) / ( 1000 + 241.38 ) = $2.90

EPS, of Firm A be after the merger = $2.90

(B).  

The PE of the acquiring firm is:

Original P/E = $29 / ( $2,700 / 1000 ) = 10.741 times

Assuming the PE ratio does not change, the new stock price will be:

New P = $2.78(14.58) = $40.53

Firm A's price per share be after the merger if the market incorrectly analyzes this reported earnings growth = $40.53

(c).

If the market correctly analyzes the earnings, the stock price will remain unchanged since this is a zero NPV acquisition, so:

New P/E = $29 / $2.90 = 10 times

The price–earnings ratio of the postmerger firm if the market correctly analyzes the transaction = 10 times

(d).

The new share price will be the combined market value of the two existing companies divided by the number of shares outstanding in the merged company. So:

P = [ (1000)*($29) + (200)*($33) ] / (1000 + 241.38 ) = $28.68

If there are no synergy gains, the share price of A be after the merger = $28.68

And the PE ratio of the merged company will be:

P/E = $38.68 / $2.90 = 9.89 times

The price–earnings ratio be = 9.89 times

Too high

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