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:

Unrealized Loss-Income

Gains or losses that have occurred on paper but are not yet realized through a transaction.

Fair Value Adjustment

Fair Value Adjustment refers to an accounting action that adjusts the reported value of an asset or liability to reflect its current market value.

Trading Securities Portfolio

A collection of securities bought and held primarily for sale in the short term to generate income on short-term price differences.

Fair Value

The estimated price at which an asset can be bought or sold in an orderly transaction between market participants at the valuation date.