Question

company A is considering acquisation by shares of company B. the following information is also available.

	Company A	Company B
present earnings	shs 100000	shs. 25000
shares	25000	10000
earnings per share	shs 10	shs 7
price/earning ratio	28	20
price of shares	shs 68	shs 31

company B has agreed to an offer of shs 70 per share to be paid in company A shares.

Required: Advice the managemet on wheter the proposed merger is viable

Answer 1

Advise to Mangement of Company A : The proposed merger is not viable since the post merger EPS of Company A ( Shs 3.54 / share) is less than the pre mrger EPS of Company A (shs 10 / share) . Reduction in EPS will result in reduction in price/earning ratio of the thecompany .

Explanation :  

The Exchange Ratio for merger= shs 70 /  shs 68 = 1.0294

Thus , 1.0294 number of shares of Company A shall be given to each share of Company B

Total number of shares to be given to Company B = Number of shares in Company B * Exchange Ratio.

10,000 shares * 1.0294 =10,294 shares

Post merger earning per share for Company A

= ( Earnings of A +  Earnings of B ) / Total number of shares post merger

= ( Shs 100,000 + Shs. 25,000) / ( 25000 shares + 10,294 shares )

= Shs 125,000 / 35,294 shares = Shs 3.54 per share