Discussion
Firm A has 100 shares outstanding at a market price of $100 each and total earnings of $600. Firm B has 100 shares outstanding at a market price of $16 each and total earnings of $200. The merger is expected to produce synergies with a present value of $600.
What will earnings per share be for Firm A after the merger, assuming that cash is used in the acquisition?
Answer: C
Correct answer: $8
Cash payment leaves A with its original 100 shares, and the merged firm earns 600 + 200 = $800, so earnings per share are $8 - up from $6 before. The rise is arithmetic rather than economic: A has acquired earnings more cheaply than its own were valued, and the price-earnings ratio falls to compensate.
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