Grow Fast Currently Sells at a Price-Earnings Multiple of 10

question 65

Essay

Grow Fast currently sells at a price-earnings multiple of 10.The firm has 2 million shares outstanding, and sells at a price per share of $40.Steady & Stable has a P/E multiple of 8, has 1 million shares outstanding, and sells at a price per share of $20.
a.If Grow Fast acquires the other firm by exchanging one of its shares for every two of Steady & Stable's, what will be the earnings per share of the merged firm?
b.If the merger has no economic gain, what will be the P/E of the new firm? What will happen to Grow Fast's price per share? Will any of the shareholders experience a change in wealth?
c.What will happen to Grow Fast's price per share if the market does not realize that the P/E ratio of the merged firm ought to differ from Grow Fast's premerger ratio? Who gains and by how much in this case?
$\begin{array}{|l|c|c|c|c|c|}\hline &\text { P/E } & \text { Shares } & \text { Price } & \text { EPS }^{*} & \text { Earnings }^{* *} \\\hline \text { GrowFast } & 10 & 2 \text { million } & \$ 40 & \$ 4.00 & \$ 8.0 \text { million } \\\hline \text { Steady \& Stable } & 8 & 1 \text { million } & \$ 20 & \$ 2.50 & \$ 2.5 \text { million } \\\hline\end{array}$

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Definitions:

Demand Curve

A graph showing the relationship between the price of a good and the quantity demanded, typically downward sloping, indicating an inverse relationship between price and quantity demanded.

Output Axis

In graphing, particularly in economics, this refers to the axis on which the quantity produced or supplied is measured.

Economic Power

The capacity of an entity, such as a company or country, to influence economic outcomes within its environment for its own benefit.

Political Power

The ability or capacity of a person or group to influence or control the actions and policies of a government or organization.