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# It indicates the market price per share of the

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Unformatted text preview: m. certain other operating and financial changes. By using the ratio of exchange, we can calculate a ratio of exchange in market price. It indicates the market price per share of the acquiring firm paid for each dollar of market price per share of the target firm. This ratio, the MPR, is defined by Equation 17.1: MPR MPacquiring RE MPtarget (17.1) where MPR MPacquiring MPtarget RE EXAMPLE market price ratio of exchange market price per share of the acquiring firm market price per share of the target firm ratio of exchange The market price of Grand Company’s stock was \$80, and that of Small Company’s was \$75. The ratio of exchange was 1.375. Substituting these values into Equation 17.1 yields a ratio of exchange in market price of 1.47 [(\$80 1.375) \$75]. This means that \$1.47 of the market price of Grand Company is given in exchange for every \$1.00 of the market price of Small Company. The ratio of exchange in market price is normally greater than 1, which indicates that to acquire a firm, the acquirer must pay a premium above its market price. Even so, the original owners of the acquiring firm may still gain, because the merged firm’s stock may sell at a price/earnings ratio above the individual premerger ratios. This results from the improved risk and return relationship perceived by shareholders and other investors. EXAMPLE The financial data developed earlier for the Grand–Small merger can be used to explain the market price effects of a merger. If the earnings of the merged company remain at the premerger levels, and if the stock of the merged company sells at an assumed multiple of 21 times earnings, the values in Table 17.7 can be expected. Although Grand Company’s earnings per share decline from \$4.00 to \$3.93 (see Table 17.5), the market price of its shares will increase from \$80.00 to \$82.53 as a result of the merger. TABLE 17.7 Postmerger Market Price of Grand Company Using a P/E Ratio of 21 Item Merged company (1) Earnings available for common stock \$600,000 (2) Number of shares of common stock outstanding (3) Earnings per share [(1) (2)] \$3.93 (4) Price/earnings (P/E) ratio (5) Expected market price per share [(3) 152,500 21 (4)] \$82.53 CHAPTER 17 Mergers, LBOs, Divestitures, and Business Failure 729 Although the behavior exhibited in this example is not unusual, the financial manager must recognize that only with proper management of the merged enterprise can its market value be improved. If the merged firm cannot achieve sufficiently high earnings in view of its risk, there is no guarantee that its market price will reach the forecast value. Nevertheless, a policy of acquiring firms with low P/Es can produce favorable results for the owners of the acquiring firm. Acquisitions are especially attractive when the acquiring firm’s stock price is high, because fewer shares must be exchanged to acquire a given firm. The Merger Negotiation Process investment bankers Financial intermediaries who, in addition to their role in selling new security issues, can be hired by acquirers in mergers to find suitable target companies and assist in negotiations. Mergers are often handled by investment bankers—financial intermediaries who, in addition to their role in selling new...
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