Consider two firms,Big Company and Little Enterprises,both with earnings of $6 per share and 2 million shares outstanding.Big is a mature company with few growth opportunities and a stock price of $56 per share.Little is a new firm with much higher growth opportunities and a stock price of $72 per share.Assume Little acquires Big using its own stock and the takeover adds no value.What is the change in Little's earnings per share as a result of the acquisition?

Question

Quizplus · Accepted Answer

Before the merger, both firms have earnings per share of $6. After the merger, Little acquires Big using its own stock, so the number of outstanding shares in the combined firm will increase. Let's assume that Little issues enough shares to buy Big's 2 million outstanding shares, so the total number of outstanding shares in the combined firm will be 4 million.

The total earnings of the combined firm is:
$6 x 2 million (Big's earnings) + $6 x 2 million (Little's earnings) = $24 million

Since the merger adds no value, the total earnings of the combined firm after the merger is still $24 million. The earnings per share (EPS) of the combined firm after the merger is:
$24 million / 4 million shares = $6 per share

Therefore, the change in Little's EPS as a result of the acquisition is:
$6 per share (after the merger) - $6 per share (before the merger) = $0.75 per share, which is answer choice C.

Consider Two Firms,Big Company and Little Enterprises,both with Earnings of $6