91Ó°ÊÓ

Assume the following financial data for Rembrandt Paint Co. and Picasso Art Supplies:

Rembrandt

Paint Co.

Picasso Art

Supplies

Total earnings ........................................................... \(1,200,000 \)3,600,000

Number of shares of stock outstanding ................... 600,000 2,400,000

Earnings per share ................................................... \(2.00 \)1.50

Price-earnings ratio (P/E) ......................................... 243 323

Market price per share.............................................. \(48 \)48

a.If all the shares of Rembrandt Paint Co. are exchanged for those of Picasso

Art Supplies on a share-for-share basis, what will post merger earnings

per share be for Picasso Art Supplies? Use an approach similar to that in

Table 20-3.

b.Explain why the earnings per share of Picasso Art Supplies changed.

c.Can we necessarily assume that Picasso Art Supplies is better off after the

merger?

Step by step solution

01

Calculation of earnings per share

To calculate the earnings per share total earnings and total outstanding shares are calculated.

$\begin{array}{rcl}\mathbf{Total}\mathbf{}\mathbf{Earning}& \mathbf{=}& \mathbf{Rembrandt}\mathbf{}\mathbf{Paint}\mathbf{}\mathbf{Co}\mathbf{.}\mathbf{}\mathbf{Earning}\mathbf{+}\mathbf{Picasso}\mathbf{}\mathbf{Art}\mathbf{}\mathbf{Supplies}\mathbf{}\mathbf{Earnings}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{200}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{3}\mathbf{,}\mathbf{600}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{800}\mathbf{,}\mathbf{000}\end{array}$

The number of shares outstanding:

$\begin{array}{rcl}\mathbf{Shares}\mathbf{}\mathbf{Outstanding}& \mathbf{=}& \mathbf{Rembrandt}\mathbf{}\mathbf{Paint}\mathbf{}\mathbf{Co}\mathbf{.}\mathbf{}\mathbf{Shares}\mathbf{+}\mathbf{Picasso}\mathbf{}\mathbf{Art}\mathbf{}\mathbf{Supplies}\mathbf{}\mathbf{Shares}\\ & \mathbf{=}& \mathbf{600}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{2}\mathbf{,}\mathbf{400}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{3}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}\end{array}$

Calculation of net earnings per share:

$\begin{array}{rcl}\mathbf{Earning}\mathbf{}\mathbf{Per}\mathbf{}\mathbf{Share}& \mathbf{=}& \frac{\mathbf{Total}\mathbf{}\mathbf{Earnings}}{\mathbf{Total}\mathbf{}\mathbf{Outstanding}\mathbf{}\mathbf{Shares}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{800}\mathbf{,}\mathbf{000}}{\mathbf{3}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{.}\mathbf{6}\mathbf{}\mathbf{per}\mathbf{}\mathbf{share}\end{array}$

02

Effect on earnings per share

Earnings per share of PA Enterprises rises as price to earnings ratio of the PA enterprises is higher than the R corporation. Any time a firm acquires another company at a lower P/E ratio than its own, there is an immediate increase in post-merger earnings per share.

03

 Performance after the merger

No, we cannot unnecessarily assume that Picasso Art Supply is better after the merger because it depends on the various factor that affects the earnings of the corporation after the merger.

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