Lecture (2)

Effect of Merger on some financial indicators:

Case Study (1):
Given the following data of the both Acquirer company
and the Target company before merger:
Acquirer Target

Share price $100 $30

Net Income after tax $600,000 $250,000
Shares outstanding 100,000 100,000
Earnings per share EPS $6 $2.5
Price to Earnings (P/E) 16.7 12
Market value of equity $10,000,000 $3,000,000
Now, given the above scenario, in order
to acquire the target company:
The acquirer will have to issue new
shares in exchange for the shares of the
target company as per the following
calculation:
• Acquirer needs to pay: $3,000,000
• Acquirer’s share price: $100
• Number of shares acquirer needs to
issue: $3,000,000 ÷ $100 = 30,000 shares
•So, as a result of the merger, there will be
a total of 130,000 shares (including
100,000 old shares and 30,000 new shares).
•The post-merger earnings of the merged
entity will be $850,000 (including $600,000
of the acquirer and $250,000 of target).
• Hence, the post-merger earnings per share will
be $6.5 as per the following calculation:
Post-merger EPS = $850,000 ÷ 130,000 = $6.5
It can clearly be seen that:
The post-merger earnings per share ($6.5)
of the acquirer is greater than the
acquirer’s earning per share before merger
($6) which is mainly due to effect of
reduction in total number of shares of the
post-merger entity which is 130,000 (instead
of 200,000) and increase in acquirer’s post-
merger earnings due to addition of the
earnings of the target.
Case Study (2):
Given the following data of the both the Acquirer
company and the Target company before merger:
Acquirer Target

Share price $100 $70

Net Income after tax $300,000 $125,000
Shares outstanding 100,000 50,000
Earnings per share EPS $3 $2.5
Price to Earnings (P/E) 33.3 28
Market value of equity $10,000,000 $3,500,000
 As per the table shown above, you are
required to calculate the following:
1) Number of shares to be issued by the
acquirer.
2) Post-merger EPS.
3) Post-merger P/E.
4) Post-merger Price.
Answer:
(1) Number of shares to be issued by the
acquirer:
=Market value of Equity of Target ÷ Share Price
of Acquirer
= $3,500,000 ÷ $100.0
= 35,000 shares
(2) Post-merger EPS:
= Total earnings of the Acquirer post-merger ÷
Total number of shares of Acquirer post-
merger
= ($300,000 + $125,000) ÷ (100,000 + 35,000)
= $3.1 P/S
(3) Post-merger P/E:
Assuming the market is efficient and
hence pre and the post-merger share price
of Acquirer will remain the same.
= Weighted average EPS of Acquirer +
Weighted average EPS of Target
= $300,000 ÷ ($300,000.0 + $125,000.0)) ×
33.3 + $125,000 ÷ ($300,000 + $125,000)) ×
28 = 31.8 Time
4) Post-merger Share Price of Acquirer:
Assuming market is not efficient, hence the
price pre share before and post-merger will
not be the same.
= Acquirer’s pre-merger P/E ratio ×
Acquirer’s post-merger EPS
= 33.3 × 3.1 = $105 P/S
Which is higher than the acquirer’s pre-
merger share price.
Case Study (3):
Company (A) is planning on merging with
company (B) will pay B’s stockholders the
current value of their stock in shares of
company (A). A currently has 2,300 shares
of stock outstanding at a market price of $20
a share. (B) has 1,800 shares outstanding at
a price of $15 a share.
Required:
How many shares of stock will be
outstanding in the merged company?
Answer:
Number of shares = Outstanding
shares of Acquirer + Outstanding
shares of target × (share price of target
÷ share price of Acquirer)
= 2,300 + (1,800 × $15 ÷ $20)
= 3,650 shares
Case Study (4):
Company A is planning on merging with Firm B. Firm
A will pay Firm B’s stockholders the current value of
their stock in shares of Firm A. Firm A currently has
2,300 shares of stock outstanding at a market price of
$20 a share. Firm B has 1,800 shares outstanding at a
price of $15 a share. The after-merger earnings will be
$6,500.
Required:
What will the earnings per share be after the merger?
Answer:
Number of shares =
2,300 + (1,800 × $15 ÷ $20)
= 3,650;
Then:
Earnings per share = $6,500 ÷ 3,650
= $1.78 P/S
Case Study (5):
Firm A is planning on merging with Firm
B. Firm A will pay Firm B’s stockholders
the current value of their stock in shares of
Firm A. Firm A currently has 2,300 shares
of stock outstanding at a market price of
$20 a share. Firm B has 1,800 shares
outstanding at a price of $15 a share. What
is the value of the merged firm?
Answer:
Value of merged firm =
Number of shares outstanding of acquirer ×
Market price per share + Number of shares
outstanding of target × Market price per share
= (2,300 × $20) + (1,800 × $15)
= $73,000
Case Study (6):
Firm A is planning on merging with Firm B.
Firm A will pay Firm B’s stockholders the
current value of their stock in shares of Firm A.
Firm A currently has 2,300 shares of stock
outstanding at a market price of $20 a share.
Firm B has 1,800 shares outstanding at a price of
$15 a share.
Required:
What is the value per share of the merged firm?
Answer:
Value per share =
[Stockholders’ equity of acquirer +
stockholders’ equity of target] ÷ [outstanding
shares of acquirer + additional shares to be
issued by acquirer]
[(2,300 × $20) + (1,800 × $15)] ÷ [2,300 + (1,800
× $15 ÷ $20)]
= $73,000 ÷ 3,650
= $20
Business Combinations:
Definitions:
It is an event or a procedure, in which, an
entity acquires net assets that constitute a
business or acquires equity interests of one
or more other entities and obtains control
over that entity or entities. Commonly,
business combinations are often referred
to as mergers and acquisitions.
Combined Enterprise:
The accounting entity that results from
a business combination.
Constituent Companies:
The business enterprises that enter into a
business combination.
Combinor:
A constituent company entering into a
purchase-type business combination whose
owners as a group end up with control of the
ownership interests in the combined
enterprises.

Combinee:
A constituent company other than the
combinor in a business combination.