Question

Progressive Ltd is determined to increase its earnings per share from $1 to $1.33, so it acquires Lo-Gear. The following facts are provided:

Item                                    Progressive                            Lo-Gear                      Merged company

Earnings per share ($)            1.00                                      1.25                                   1.33

Price per share ($)                 20.00                                    12.50                                      ?

Price-earnings ratio               20.00                                    10.00                                      ?

Number of shares                 100000                                200000                                     ?

Total earnings ($)                 100000                                250000                                     ?

Total market value ($)         2 000000                             2500000                                    ?

There are no economic benefits from combining the two companies. In exchange for Lo-Gear's shares, Progressive issues just enough of its own shares to ensure its $1.33 earnings-per-share objective.

Please provide answers with explanation.

1. Calculate the number of shares of the merged company.

2.How many shares of Progressive are exchanged for each share of Lo-Gear?

3.What is the net cost of the takeover to Progressive?

Answer 1

Solution:-

(1) Number of shares of the merged entity= Total earnings of the merged entity/EPS = (100,000+250,000)/1.33= 263,158 shares

(2) No. of shares exchanged per share of Lo-Gear= (Total shares of merged entity-Number of shares of progressive)/No. of share of Lo-Gear = (263,158-100,000)/200,000 = 0.82 shares

(3) Since, there are no economic benefits of the combination, it is safe to assume that the combined market value of merged entity will be equal to the sum of individual market values of two companies before combination

Total market value of merged entity= 2,000,000 + 2,500,000 = $4,500,000.

Share of progressive in merged entity's market value = 4,500,000*(100,000/263,158) = $1,710,000

Net cost to progressive= 1,710,000-2000,000= $290,000