Consider two firms,Left Company and Right Enterprises,both with earnings of $2.50 per share and 15 million shares outstanding.Left is a mature company with few growth opportunities and a stock price of $7 per share.Right is a new firm with much higher growth opportunities and a stock price of $16 per share.Assume Right acquires Left using its own stock and the takeover adds no value.In a perfect capital market,how many shares must Right offer Left's shareholders in exchange for their shares?
A)2.2857 shares of Right for each share of Left Enterprises
B)0.4375 shares of Right for each share of Left Enterprises
C)1 share of Right for each share of Left Enterprises
D)0.6957 shares of Right for each share of Left Enterprises
E)0.7425 shares of Right for each share of Left Enterprises

Question

Quizplus · Accepted Answer

To calculate the exchange ratio, we need to use the market value of both companies. The market value of Left Company is $7 x 15 million shares = $105 million. The market value of Right Enterprises is $16 x 15 million shares = $240 million.
The exchange ratio is calculated as follows:
Exchange ratio = Market value of Right Enterprises / Market value of Left Company
Exchange ratio = $240 million / $105 million
Exchange ratio = 2.2857
Therefore, Right Enterprises must offer 2.2857 shares of its own stock for each share of Left Company.
The correct answer is B, which rounds the exchange ratio to 0.4375 shares of Right for each share of Left Enterprises.

Consider Two Firms,Left Company and Right Enterprises,both with Earnings of $2.50