When Firm A acquired Firm B, no incremental value was created but earnings per share increased. If the ﬁnancial markets are astute, the price-earnings ratio of Firm A should ____ and the stock
Price of Firm A should _____.
A) decrease; decrease
B) decrease; increase
C) decrease; remain constant
D) increase; decrease
E) increase; increase

Question

Quizplus · Accepted Answer

When Firm A acquires Firm B without creating any incremental value, there is no reason for the financial markets to assign a higher price-earnings ratio to Firm A. Therefore, the price-earnings ratio of Firm A should decrease or remain constant. However, since earnings per share have increased, the stock price of Firm A may not necessarily decrease but may remain constant or increase slightly. Hence, the best answer is C.

When Firm a Acquired Firm B, No Incremental Value Was