Question

170118/mod resource/content//AC (a) You are given the following information in relation to Percussion Ltd: Sales £29,250,000 Gross profit margin 10% General expenses £675,000 Tax £450,000 400,000 Number of shares issued at start of the period Number of shares issued at full market price of £190 per share for cash, half way through the period 320,000 1 Required: (0) Calculate the price earnings ratio and the earnings per share for Percussion Ltd. (1) If a company has a high price earnings ratio, what might this indicate about the company? How might the price earnings ratio change if a company increased its gearing? Your answer to this part of the question should not be more than 100 words. (8 marks) (b) Discuss 5 differences between merger accounting and acquisition accounting and the reasons why merger accounting is no longer in use. Your answer to this part of the question should not be more than 150 words.

Answer 1

Answer: (a) - (i)
Percussion Ltd.
Sl. No.	Description	Amount (in €)
I.
1.	Sales	29,250,000
2.	Gross Profit (10% on Sales)	2,925,000
3.	General Expenses	675,000
4.	Profit Before Tax (PBT)	2,250,000
5.	Tax	450,000
6.	Profit After Tax (PAT)	1,800,000
II.
1.	Profit After Tax (PAT)	1,800,000
2.	Total No. Of Shares	720,000
3.	Earnings per Share (1,800,000 ÷ 720,000)	2.5
III.
1.	Market Price of Share	190
2.	Earnings per Share	2.5
3.	Price to Earnings Ratio (190 ÷ 2.5)	76

Answer: (a) - (ii)

If a Company has a higher PE Ratio, then it indicates that the prospects of the Company are rich. On the contrary it is also that the Company may result in a lower financial leverage and the stocks are possibly over-valuated. Theoretically speaking, if a Company increase its gearing, i.e., financial leverage, then it will lower the PE Ratio but substantially increase the Value of the Shares. This would in turn lead to a higher stock volatility. However, in reality, there are studies which has found that, if there is an increase in the leverage, the PE Ratio remains indeterminate.

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