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) Exchange ratio = price per share offered for target company / Market price per share for acquiring company

= $50/$60 = 0.8333(Acquiring company issue 0.8333 shares of stock for each share of target company's stock)

2) New shares issued by Acquiring company= 20,000(shares of target company) x 0.8333(Exchange ratio) =16,666

3) Post merger EPS of the combined company = $180000/ 76,666 = $2.35

(total earnings=$150000+$30000 that is $180000 and total share of combined companies = 60000+16,666=76,666)

4) Post merger share price of combined company:

Price = P/E ratio of Pre- merged company x Post merger EPS

Pre merger EPS Of Acquiring company = $150,000 / $60000 = $2.5

P/E ratio= $60 /$ 2.5 =24

so post merger share price= $2.35 x 24 = $56.4

(It is given in question that P/E ratio will remain same after merger)

5) In this scenario purchase price =$50 x 20000 shares = $1,000,000

Interest expenses = 1,000,000 x 8% = $80,000

tax rate = 40%

net interest = 80,000(1-.04) = 48000

Post merger Earnings = 150000+30000-48000 = 132000

so post merger EPS of the combined companies = $132000 / 60,000 = 2.2

(Since the purchase is done using cash the number of outstanding shares will remain same)