BMS - Fm - Business restructuring revision problem

XYZ Ltd., is considering merger with ABC Ltd. XYZ Ltd.’s shares are currently traded at Rs.

20. It has 2,50,000 shares outstanding and its earnings after taxes (EAT) amount to Rs.

5,00,000. ABC Ltd., has 1,25,000 shares outstanding; its current market price is Rs. 10 and

its EAT are Rs. 1,25,000. The merger will be effected by means of a stock swap (exchange).

ABC Ltd., has agreed to a plan under which XYZ Ltd., will offer the current market value of

ABC Ltd.’s shares:

(i) What is the pre-merger earnings per share (EPS) and P/E ratios of both the companies?

(ii) If ABC Ltd.’s P/E ratio is 6.4, what is its current market price? What is the exchange

ratio? What will XYZ Ltd.’s post-merger EPS be?

(iii) What should be the exchange ratio, if XYZ Ltd.’s pre-merger and post-merger EPS are to

be the same?

Solution

(i) Pre-merger EPS and P/E ratios of XYZ Ltd. and ABC Ltd.
Particulars XYZ Ltd. ABC Ltd.
Earning after taxes 5,00,000 1,25,000
Number of shares outstanding 2,50,000 1,25,000
EPS 2 1
Market Price per share 20 10
P/E Ratio (times) 10 10

(ii) Current Market Price of ABC Ltd. if P/E ratio is 6.4 = Rs. 1 × 6.4 = Rs. 6.40
Exchange ratio =
6.40
Rs.20 - = 3.125
Post merger EPS of XYZ Ltd.
=
Rs.2,50,000 (Rs.1,25,000/3.125)
Rs.5,00,000 Rs.1,25,000


=
Rs.2,90,000
Rs.6,25,000 = 2.16
(iii) Desired exchange ratio
Total number of shares in post-merged company
=
Pre -merger EPS of XYZ Ltd
Post -merger earnings =
2
Rs.6,25,000 = 3,12,500
Number of shares required to be issued
= 3,12,500 – 2,50,000 = 62,500
Therefore, the exchange ratio is
62,500 1,25,000
=
1,25,000
62,500 = 0.50