Question

		Firm A		Firm T
Price per share		$100.00		$20.00
Total earnings		$650.00		$150.00
Share outstanding		100		40
Total Value		$10,000.00		800.00

Suppose Company A will acquire Company T. Company A will offer two new share of A for every five shares of T.

a. If investors are aware that there are no economic gains from the merger, what is the price-earnings ratio of A's stock after the merger? _________ (sample answer: 27.50)
b.Now suppose that the merger really does increase the value of the combined firms by $800, what is the price-earnings ratio of A's stock after the merger? _________ (sample answer: 27.50)
c. Now suppose that the merger really does increase the value of the combined firms by $800, What is the final merger premium in dollar does Company A pay to Company T __________(sample answer: $450.50)

Answer 1

a) For 5 shares of T, A will offer 2 shares

Hence for 40 shares of T, A will offer 8 shares

After merger, total shares outstanding = 116

Total value = 10000+800 = 10,800 (since there is no economic gains after merger)

Share price of merged entity = Total value/total shares outstanding = 10800/116 = $93.1034

Total earnings after merger = Earnings of T + Earnings of A = $(650+150) = $800

EPS of merged entity = Total earnings/ total shares outstanding = 800/116 = 6.8965

P/E after merger = Price per share after merger / EPS of merged entity = 93.1034/6.8965

P/E after merger = 13.50

(b) After merger, total shares outstanding = 116

Total value after merger = 10000+800+800 = 11,600

Share price of merged entity = Total value/total shares outstanding = 11600/116 = $100

Total earnings after merger = Earnings of T + Earnings of A = $(650+150) = $800

EPS of merged entity = Total earnings/ total shares outstanding = 800/116 = 6.8965

P/E after merger = Price per share after merger / EPS of merged entity = 100/6.8965

P/E after merger = 14.50

c) Share price of merged entity =$100

Before merger, price of 40 shares = 40*20 = $800

Share price of merged entity = $100
After merger share price of 16 shares= $1600

Total Merger premium = $1600- $800 = $800
Merger premium per share of T = 800/40 = $20