B Ltd is a highly successful company and wishes to expand by acquiring other fir

Question

B Ltd is a highly successful company and wishes to expand by acquiring other firms. Its expected high growth in earnings and dividends is reflected in its PE ratio of 17. The Board of Directors of B Ltd. has been advised that if it were to take over firms with a lower PE ratio than its own, using a share for share exchange, then it could increase its reported earnings per share. C Ltd has been suggested as a possible target for a takeover which has a PE ratio of 10 and 1,00,000 shares in issue with a share price of Rs.15. B Ltd has 5,00,000 shares in issue with a share price of Rs.12.

Calculate the change in EPS of B Ltd. if it acquires the whole of C Ltd. by issuing shares at its market price of Rs.12. Assume the price of B Ltd. shares remain constant.

Explanation / Answer

PE ratio of B = 17
PE ratio = Market price/EPS
17 = 12/EPS
EPS = 12/17
= 0.71
EPS = earnings/no. of shares
0.71 = earnings/500000
earnings = 0.71 * 500000
= $355,000
Similarly, earnings of C can be calculated
PE = 15/EPS
EPS = 15/10
= 1.5
Earnings = EPS*No of shares
= 1.5 * 100000
= $150,000
Using the PE multiple for making an offer to C, the total consideration payable in shares is
= 150,000 * 10
= $1,500,000
Dividing this by the market price per share issued,
= 1500000/12 = 125,000 shares
New EPS of B = Earnings/No. of new shares
= 355,000/500000+125000
= 355000/625000
= 0.57 per share

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.