Question

Acquiring Company is considering the acquisition of Target Company in a stock for stock transaction in which Target Company would receive $50.00 for each share of its common stock. The Acquiring Company does not expect any change in its price/earnings multiple after the merger.

Acquiring Co. Target Co.

Earnings available for common stock $150,000 $30,000

Number of shares of common stock outstanding $60,000 $20,000

Market price per share $60.00 $40.00

Using the information provided above on these two firms and showing your work, calculate the following:

1) What is the share exchange ratio?

2) How many new shares will be issued by Acquiring Company?

3) What is the post-merger EPS of the combined company?

4) What is the post-merger share price of the combined company?

5) If the purchase is using 100% cash and all the cash is borrowed at an annual rate of 8%, what is post-merger EPS of the combined company, assuming the tax rate is 40%?

Answer 1

1) 0.8333

2) 16,666

3) 2.33

4) 56.40

5) 2.2

Step-by-step explanation:

Share Exchange Ratio = Price per share for Target Company / Market price per share for Acquiring Company = $50 / $60 = 0.8333

New shares issued by Acquiring Company = Shares of Target Company x Exchange ratio (20,000 x 0.8333) = 16,666

Total shares outstanding of the combined companies = 60,000 + 16,666 = 76,666

Post-merger EPS of the combined companies = ($150,000 + $30,000)/ 76,666 = $2.35

Pre-merger EPS of Acquiring Company = $150,000 / 60,000 = $2.50

Post-merger share price = $2.35 x 24 (pre-merger P/E = $60.00/$2.50) = $56.40

Purchase price = 50 * 20,000 = 1,000,000

Interest expense = 1,000,000 * 8% = 80,000

Post-merger earnings = 150,000 + 30,000 – 80,000 * (1-0.4) = 132,000

Therefore, Post-merger EPS of the combined companies = 132,000/60,000 = 2.2