This preview shows page 1. Sign up to view the full content.
Unformatted text preview: s common stock for each share of Small Company. Other key financial data and
the effects of this exchange ratio were discussed in preceding examples. The total
earnings of Grand Company were expected to grow at an annual rate of 3%
without the merger; Small Company’s earnings were expected to grow at a 7%
annual rate without the merger. The same growth rates are expected to apply to
the component earnings streams with the merger.7 The table in Figure 17.1 shows
the future effects on EPS for Grand Company without and with the proposed
Small Company merger, on the basis of these growth rates.
The table indicates that the earnings per share without the merger will be
greater than the EPS with the merger for the years 2003 through 2005. After
2005, however, the EPS will be higher than they would have been without the 7. Frequently, because of synergy, the combined earnings stream is greater than the sum of the individual earnings
streams. This possibility is ignored here. CHAPTER 17 Mergers, LBOs, Divestitures, and Business Failure 727 FIGURE 17.1
Future EPS without and with
the Grand–Small merger 5.00 With Merger EPS ($) 4.50
Without Merger 4.00 3.50 2003 2004 2005 2006 2007 2008 Year
4.64 With Merger
4.72 a Based on a 3% annual growth rate.
Based on 125,000 shares outstanding.
Based on a 3% annual growth in the Grand Company‘s earnings and a 7%
annual growth in the Small Company‘s earnings.
Based on 152,500 shares outstanding [125,000 shares + (1.375 × 20,000 shares)].
b merger as a result of the faster earnings growth rate of Small Company (7% versus 3%). Although a few years are required for this difference in the growth rate
of earnings to pay off, in the future Grand Company will receive an earnings benefit as a result of merging with Small Company at a 1.375 ratio of exchange. The
long-run earnings advantage of the merger is clearly depicted in Figure 17.1.8 Effect on Market Price Per Share
The market price per share does not necessarily remain constant after the acquisition of one firm by another. Adjustments occur in the marketplace in response
to changes in expected earnings, the dilution of ownership, changes in risk, and 8. To discover properly whether the merger is beneficial, the earnings estimates under each alternative would have to
be made over a long period of time—say, 50 years—and then converted to cash flows and discounted at the appropriate rate. The alternative with the higher present value would be preferred. For simplicity, only the basic intuitive
view of the long-run effect is presented here. 728 PART 6 Special Topics in Managerial Finance ratio of exchange in market price
Indicates the market price per
share of the acquiring firm paid
for each dollar of market price
per share of the target fir...
View Full Document