Question

Diawuo Comapany is acquiring Ohia Company. Diawuo will issue one of its shares for every two shares of Ohia Company. The data for the two companies are given below.
Diawuo Ohia
Profit after tax (GHC’000) 150 30
Number of shares (thousands) 25 8
Earnings per share (GHC) 6.00 3.75
Market price of share (GHC) 78.00 33.75
Price-earnings Ratio 13 9
You are required to deal with the following:
i. Calculate the earnings per share of the surviving firm after the merger.
ii. If the price-earnings ratio falls to 12 after the merger, what is the premium received by the shareholders of Ohia (using the surviving firm’s new price)?
iii. Is the merger beneficial for Diawuo’s shareholders?

Answer 1

Total no. of shares of Diawuo post merger = Pre-merger shares of Diawuo + new shares issued = 25 + 8/2 = 25+4= 29 ('000)

Total earnings post merger of combined firm = 150 + 30 = 180 ('000)

Solution: i)

EPS post merger = Total earnings post merger of combined firm / Total no. of shares of new co. = 180/ 29 = 6.21 (GHC)

Solution ii)

Given: Post merger P/E ratio = 12 => Price/EPS = Price/6.21 = 12 => Price post-merger = 74.52 per share

Market value of new firm = 74.52 * 29 ('000)= 2161.08 ('000)

Market value of new firm belonging to target co. shareholders = 2161.08 * 4/29 = 298.08 ('000)

premium to target shareholders = 298.08 less: pre-meger value of target co. = 298.08 - (8*33.75) = 298.08 - 270 = 28.08 ('000)

iii) the target co. shareholders are in a benefit as they have received way above what the target co. was worth prior to merger.