3 because the stock price of global after the merger

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3. Because the stock price of Global after the merger is the same as that before the merger, the price-earnings ratio must fall. This is true as long as the market is smart and recognizes that the total market value has not been altered by the merger. If the market is “fooled,” it might mistake the 43 percent increase in earnings per share for true growth. In this case, the price-earnings ratio of Global may not fall after the merger. Suppose the price-earnings ratio of Global remains equal to 25. Because the combined firm has earnings of $200, the total value of the combined firm will increase to $5,000 ( 25 $200). The per-share value for Global will increase to $35.71 ( $5,000/140). This is earnings growth magic. Like all good magic, it is just an illusion. For it to work, the shareholders of Global and Regional must receive something for nothing. This, of course, is unlikely with so simple a trick. Diversification Diversification is commonly mentioned as a benefit of a merger. The problem is that diver- sification per se probably does not create value. Going back to Chapter 11, recall that diversification reduces unsystematic risk. We also saw that the value of an asset depends on its systematic risk, and systematic risk is not di- rectly affected by diversification. Because the unsystematic risk is not especially important, there is no particular benefit from reducing it. An easy way to see why diversification isn’t an important benefit of a merger is to con- sider someone who owned stock in two companies that were proposing to merge. Such a stockholder was already diversified between these two investments. The merger didn’t do anything the stockholder couldn’t do for herself. More generally, stockholders can get all the diversification they want by buying stock in different companies. As a result, they won’t pay a premium for a merged company just for the benefit of diversification. In fact, diversification may actually harm stockholders when GLOBAL RESOURCES BEFORE MERGER REGIONAL ENTERPRISES BEFORE MERGER Global Resources After Merger THE MARKET IS SMART THE MARKET IS FOOLED Earnings per share Price per share Price-earnings ratio Number of shares Total earnings Total value $ 1 $ 25 25 100 $ 100 $2,500 $ 1 $ 10 10 100 $ 100 $1,000 $ 1.43 $ 25 17.5 140 $ 200 $3,500 $ 1.43 $ 35.71 25 140 $ 200 $5,000 Exchange ratio: 1 share in Global for 2.5 shares in Regional. TABLE 21.3 Financial Positions of Global Resources and Regional Enterprises
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14 one or both firms are leveraged. This point is discussed in Chapter 15, which should be consulted for greater detail on this important consideration. 2 1 . 6 T H E C O S T O F A N A C Q U I S I T I O N We’ve discussed some of the benefits of acquisitions. We now need to discuss the cost of a merger. We learned earlier that the net incremental gain from a merger is: V V AB ( V A V B ) Also, the total value of Firm B to Firm A, V B * , is: V B * V B V The NPV of the merger is therefore: NPV V B * Cost to Firm A of the acquisition [21.1] To illustrate, suppose we have the following premerger information for Firm A and Firm B: FIRM A FIRM B Price per share Number of shares
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  • Spring '12
  • Scott
  • Firm, Firm B

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