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?

---

Definitions:

Merchandise

Goods bought for resale in the course of business, typically in a retail or wholesale establishment.

Payments

The act of transferring money in exchange for goods or services, or to settle debts.

Inventory System

A mechanism for tracking and managing items that a company holds in stock, covering aspects like ordering, storing, using, and selling these goods.

Perpetual

Continuing indefinitely without a predetermined end in the context of perpetual inventory systems that continually update to reflect buying and selling activities.