Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-earnings (P/E) ratio both pre and post merger
What will be an ideal response?
Answer: Premerger P/E = price per share / earning price per share = $32.00 / $3 = 10.67
First, since Martin is paying for the merger with stock, the number of shares that Martin must issue
= ($2.50 × 2 million) / $32 = 1.25 million
So the total number of shares in the new merged firm
= 5 million (existing Martin shares) + 1.25 million new shares = 6.25 million shares.
Total earnings for the merged firm = Earnings from Martin + Earnings from Luther.
Earnings from Martin = EPS × shares outstanding = $3.00 × 5 million = $15 million
Earnings from Luther = EPS × shares outstanding = $2.50 × 2 million = $5 million
Total earnings = $15 + $5 = $20 million
EPS of merged firm = $20 million / 6.25 million = $3.20
Post merger P/E = Price per share / earning per share = $32 / $3.20 = $10
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