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In early 2011 Giant Inc.'s management was considering making an offer to buy Micro Corporation....

Question:

In early 2011 Giant Inc.'s management was considering making an offer to buy Micro Corporation. Micro's projected operating income (EBIT) for 2011 was $30 million, but Giant believes that if the two firms were merged, it could consolidate some operations, reduce Micro's expenses, and raise its EBIT to $35 million. Neither company uses any debt, and they both pay income taxes at a 35% rate. Giant has a better reputation among investors, who regard it as very well managed and not very risky, so its stock has a P/E ratio of 12 versus a P/E of 9 for Micro. Since Giant's management would be running the entire enterprise after a merger, investors would value the resulting corporation based on Giant's P/E. If Micro has 10 million shares outstanding, by how much should the merger increase its share price, assuming all of the synergy will go to its stockholders?

Earning Per Share:

The investors purchase the shares of the company. The average increase in the prices of the share is known as the earning per share. This is a basic method to calculate the return on equity.

Answer and Explanation:

EPS of micro before merger= $30m (1-35%)/10m

=$1.95

P/E ratio=9

Price before merger=9* EPS of micro before merger

=9*$1.95

=$17.55

EPS after merger=$35m (1-35%)/10m

=$2.275

P/E ratio=12

Price after merger=12*EPS after merger

=12*$2.275

=$27.3

Increase in share price=$27.3-$17.55

=$9.75


Learn more about this topic:

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Calculating Earnings Per Share for Post-Retirement Benefits

from Accounting 202: Intermediate Accounting II

Chapter 9 / Lesson 4
288

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