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Chapter 5: Q3DQ. (page 647)
Why might the portfolio effect of a merger provide a higher valuation for the participating firms?
Answer
Merger results in risk reduction for the participating companies, and also maintains the rate of return, it results in higher valuation to the participating companies.
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What is the purpose(s) of the two-step buyout from the viewpoint of the acquiring company?
Assume the Knight Corporation is considering the acquisition of Day Inc. The expected earnings per share for the Knight Corporation will be \(4.00 with or without the merger. However, the standard deviation of the earnings will go from \)2.40 to $1.60 with the merger because the two firms are negatively correlated.
a.Compute the coefficient of variation for the Knight Corporation before and after the merger (consult Chapter 13 to review statistical concepts if necessary).
b.Discuss the possible impact on Knight鈥檚 postmerger P/E ratio, assuming investors are risk-averse.
General Meters is considering two mergers. The first is with Firm A in its own
volatile industry, the auto speedometer industry, while the second is a merger
with Firm B in an industry that moves in the opposite direction (and will tend to
level out performance due to negative correlation).
General Meters Merger
with Firm A
General Meters Merger
with Firm B
Possible
Earnings
(\( in millions) Probability
Possible
Earnings
(\) in millions) Probability
\(40 ........... 0.30 \)40 ........... 0.25
60 ........... 0.40 60 ........... 0.50
80 ........... 0.30 80 ........... 0.25
aCompute the mean, standard deviation, and coefficient of variation for both
investments (refer to Chapter 13 if necessary).
b.Assuming investors are risk-averse, which alternative can be expected to
bring the higher valuation?
The postmerger P/E ratio can move in a direction opposite to that of the immediate postmerger earnings per share. Explain why this could happen
Assume the following financial data for the Noble Corporation and Barnes
Enterprises:
Noble
Corporation
Barnes
Enterprises
Total earnings ......................................................... \(1,820,000 \)5,620,000
Number of shares of stock outstanding ................. 650,000 2,810,000
Earnings per share ................................................. \(2.80 \)2.00
Price-earnings ratio (P/E) ....................................... 203 283
Market price per share............................................ \(56 \)56
a.If all the shares of the Noble Corporation are exchanged for those of Barnes
Enterprises on a share-for-share basis, what will postmerger earnings per share
be for Barnes Enterprises? Use an approach similar to that in Table 20-3.
b.Explain why the earnings per share of Barnes Enterprises changed.
c.Can we necessarily assume that Barnes Enterprises is better off after the
merger?
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