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Consider the following premerger information about Firm A and Firm B: |
| Firm A | Firm B | |||||
| Total earnings | $ | 2,300 | $ | 700 | ||
| Shares outstanding | 1,000 | 200 | ||||
| Price per share | $ | 25 | $ | 29 | ||
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Assume that Firm A acquires Firm B via an exchange of stock at a price of $31 for each share of B's stock. Both Firm A and Firm 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.) |
| 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.) |
| 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.) |
| d-1. | If there are no synergy gains, what will the share price of Firm A be after the merger? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
| 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.) |
| d-3. | What does your answer for the share price tell you about the amount Firm A bid for Firm B? Was it too high? Too low? |
a. EPS = (Total Earnings) / (Firm A Equity + Firm B Purchased Equity)
EPS = $3000 / (1000 + (200*31/25))
EPS = $3000 / (1000 + 248)
EPS of merged entity= $2.40
b. PE Ratio of Firm A = Market price / Earnings per share = $25 / $2.30 = 10.87
Firm A's price per Share = PE Ratio * EPS of Merged Firm
Firm A's price per Share = $26.13
c. PE Ratio when market correctly analyzes = current Firm A price / EPS of merged firm
PE Ratio when market correctly analyzes = 25 / 2.40
PE Ratio when market correctly analyzes = 10.40
d1. Share price after merger = market value of merged Firm / Shares O/s
Share price after merger = 30800 / 1248
Share price after merger = $24.68
d2. PE Ratio = Share price after merger / EPS of merged entity
PE Ratio = $24.68 / 2.40
PE Ratio = 10.27
d3. The new price of Firm A is lower than before, Thus the Bid is Too High
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