GrowFast Currently Sells at a Price-Earnings Multiple of 10

question 66

Essay

GrowFast 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 GrowFast 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 GrowFast's price per share? Will any of the shareholders experience a change in wealth?
c. What will happen to GrowFast's price per share if the market does not realize that the P/E ratio of the merged firm ought to differ from GrowFast's premerger ratio? Who gains and by how much in this case?

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Definitions:

Aggregate Demand

Aggregate demand is the total demand for all goods and services in an economy at a given overall price level and in a given time period.

Tennis Balls

are small, fluorescent colored balls covered with felt, used in the game of tennis.

Market Demand Curve

A graphical representation of the quantity of goods demanded at different prices by all consumers in the market.

Export Demand

is the desire and willingness of foreign buyers to purchase goods and services from a country, influenced by factors such as price, quality, and exchange rates.