Finance I, Problem Set 8 Questions: Mergers and Acquisitions
1. Evaluate the following comments.
a. “Our cost of debt is high because we’re a pure-play healthcare company and
vulnerable to changes in healthcare regulation. We should buy a water
company to diversify and reduce our cost of debt.”
b. “Merge with Fledgling Electronics? No way! Their P/E’s too high. That deal
would knock 20% off our earnings per share”.
c. “Our business is offering cable TV, broadband, and telephone services to
households. We should buy a company that makes TV programmes, so that we
can offer better products to our customers.”
2. Steinberg is investigating a possible merger with Dietrich, which is currently
unanticipated by the market. Here is basic information about the two companies
for the last financial year. Both companies are all-equity financed.
Steinberg Dietrich
Earnings per share €6.00 €8.80
Current dividends per share €3.73 €5.28
Number of shares 10 million 5.5 million
Stock price €60 €85
Both Steinberg and Dietrich are mature firms, with forecasted growth of 2.5% per
year. Steinberg’s treasurer believes that post-merger cost savings could generate a
one-time permanent 15% increase in the two firms’ combined earnings. Dividend
payout would increase proportionally, although long-term growth would remain at
2.5% per year.
a. What is the total merger gain? Hint: use the current stock prices to calculate the
current costs of equity.
b. What is the acquisition premium if Steinberg borrows €600 million and pays
this amount in cash for Dietrich?
c. Suppose that Steinberg offers 1.65 Steinberg shares for each Dietrich share.
What is the acquisition premium in this case?
3. Nedwin is determined to report earnings per share of $2.67. It therefore acquires
the Feldmania Company. You are given the following facts:
Nedwin Feldmania Merged Firm
Earnings per
share
$2.00 $2.50 $2.67
Price per share $40 $25 ?
Price-earnings
ratio
20 10 ?
Number of
shares
100,000 200,000 ?
2
=
Total earnings $200,000 $500,000 ?
Total market
value
$4,000,000 $5,000,000 ?
There are no gains from merging. In exchange for Feldmania shares, Nedwin
issues just enough of its own shares to achieve its $2.67 EPS objective.
a. Complete the above table for the merged firm.
b. How many shares of Nedwin are exchanged for each share of Feldmania?
c. What is the acquisition premium paid by Nedwin?
d. What is the change in the total market value of the Nedwin shares that were
outstanding before the merge