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 pricelearnings multiple after the merger. Acquiring Co. $150,000 Target Co. $30,000 Earnings available for common stock 60,000 20,000 Number of shares of common stock outstanding Market price per share $60.00 $40.00 Using the information provided above on these two firms and showing your work, calculate the following:

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

2)Since cash is paid to carry out acquisitions ,No new shares are issued by acquiring company.

New shares issued = 0

3)Total Earnings of combined company = 150000+30000 = 180000

Number of shares outstanding = 60000

Earning per share of combined company= Total Earnings of combined company/Number of shares outstanding

                         = 180000/ 60000

                         = $ 3 per share

4)Earning per share (pre merger) for acquiring company= 150000/60000 = $ 2.5 per share

PE ratio =market price per share /earning per share

           = 60 / 2.5

            = 24

Since no change in PE ratio is anticipated by acquiring company ,Market price per share (post merger) = PE ratio * Post merger earning per share

             = 24 * 3

            = $72 per share

5)Total cash paid to shareholders of target company =number of shares of target company*cash paid per share

                       = 20000 *50

                      = 1000000

Interest on cash borrowed= 1000000 *8% = 80000

Interest cost ,net of tax = 80000[1-.40 ] = 48000

Earnings of acquiring company	150000
Earnings of target company	30000
Total combined earnings	180000
less: Interest cost ,net of tax	-48000
Net combined earnings	132000
number of shares outstanding post merger	60000
EPS post merger	132000/60000 =$ 2.2 per share