The shareholders of Jolie Company have voted in favor of a buyout offer from Pitt Corporation.Information about each firm is given here: $$\begin{array} { l r r }
& \underline { \text { Jolie } } & \underline { \text { Pitt } } \
\text { Price-earnings ratio } & 6 & 12 \
\text { Shares outstanding } & 62,000 & 124,000 \
\text { Earnings } & \$ 210,000 & \$ 630,000
\end{array}$$ Jolie's shareholders will receive one share of Pitt stock for every three shares they hold in Jolie.Assume the NPV of the acquisition is zero.What will the post-merger PE ratio be for Pitt?
A)8.4
B)9.2
C)9.8
D)10.5
E)11.2

Question

The shareholders of Jolie Company have voted in favor of a buyout offer from Pitt Corporation.Information about each firm is given here: $$\begin{array} { l r r } 
& \underline { \text { Jolie } } & \underline { \text { Pitt } } \
\text { Price-earnings ratio } & 6 & 12 \
\text { Shares outstanding } & 62,000 & 124,000 \
\text { Earnings } & \$ 210,000 & \$ 630,000
\end{array}$$ Jolie's shareholders will receive one share of Pitt stock for every three shares they hold in Jolie.Assume the NPV of the acquisition is zero.What will the post-merger PE ratio be for Pitt?
A)8.4
B)9.2
C)9.8
D)10.5
E)11.2

Quizplus · Accepted Answer

The EPS of the combined company will be the sum of the earnings of both companies divided by the number of shares in the combined company. Since the stock offer is one share of the acquiring firm for three shares of the target firm, net shares in the acquiring firm will increase by one-third of the target firm's current shares. So, the new EPS will be:EPS = ($210,000 + $630,000)/[124,000 + (1/3)(62,000)] = $5.81The market price of Pitt will remain unchanged if it is a zero NPV acquisition. Using the PE ratio, we find the current market price of Pitt stock, which is:P = 12($630,000)/124,000 = $60.967742If the acquisition has a zero NPV, the stock price should remain unchanged. Therefore, the new PE will be:PE = $60.967742/$5.81 = 10.5

The Shareholders of Jolie Company Have Voted in Favor of a Buyout