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


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


P/E ratio=9

Price before merger=9* EPS of micro before merger



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


P/E ratio=12

Price after merger=12*EPS after merger



Increase in share price=$27.3-$17.55


Learn more about this topic:

Calculating Earnings Per Share for Post-Retirement Benefits

from Accounting 202: Intermediate Accounting II

Chapter 9 / Lesson 4

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