Problem 20-6 Problem 20-11
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Foundations of Financial Management
MAIN MENU – CHAPTER 20
External Growth through Mergers
Problem 20-6
Objective: Impact of merger on earnings per share
Student Name:
Course Name:
Student ID:
Course Number:
Assume the following financial data for Noble Corporation and Barnes Enterprises:
Noble Barnes
Corporation Enterprises
Total earnings
$1,200,000 $3,600,000
Number of shares of stock outstanding
600,000 2,400,000
Earnings per share
$2.00 $1.50
Price-earnings ratio (P/E)
24× 32×
Market price per share
$48 $48
a. If all the shares of the Noble Corporation are exchanged for those of Barnes Enterprises on a share-for-share basis,
what will postmerger earnings per share be for Barnes Enterprises? Use an approach similar to that of Table 20–3
on page 627.
b. Explain why the earnings per share of Barnes Enterprises changed.
c. Can we necessarily assume that Barnes Enterprises is better off after the merger?
Foundations of Financial Management
Block, Hirt and Danielsen
Problem 20-6
Instructions
Enter data and formulas to complete the requirements of this problem.
a. If all the shares of the Noble Corporation are exchanged for those of Barnes Enterprises on a share-for-share basis,
what will postmerger earnings per share be for Barnes Enterprises? Use an approach similar to that of Table 20–3
on page 627.
Total
Earnings
Noble Corporation $1,200,000
Barnes Enterprises 3,600,000
Combined earnings $4,800,000
Shares
Outstanding in
Surviving
Corporation
Old 2,400,000
New 600,000
Postmerger Shares Outstanding 3,000,000
New EPS $1.60
b. Explain why the earnings per share of Barnes Enterprises changed.
Earnings per share of Barnes Enterprises increased because it has a higher P/E ratio than Noble Corporation
(32x versus 24x). Any time a firm acquires another Company at a lower P/E ratio than its own, there is an
immediate increase in postmerger earnings per share.
better off. We need to know whether the Noble Corporation will increase or decrease the future growth
in earnings per share for the Barnes Enterprises and how it will influence its postmerger P/E ratio.
The goal of financial management is not just immediate growth in earnings per share, but maximization
of stockholder wealth over the long-term
Solution
Problem 20-11
Objective: Portfolio effect of a merger
Student Name:
Course Name:
Student ID:
Course Number:
Assume the Shelton Corporation is considering the acquisition of Cook, Inc. The expected earnings per share for the
Shelton Corporation will be $3.00 with or without the merger. However, the standard deviation of the earnings will
go from $1.89 to $1.20 with the merger because the two firms are negatively correlated.
a. Compute the coefficient of variation for the Shelton Corporation before and after the merger.
(consult Chapter 13 to review statistical concepts if necessary).
b. Comment on the possible impact on Shelton’s postmerger P/E ratio, assuming investors are risk-averse.
Foundations of Financial Management
Block, Hirt and Danielsen
Problem 20-11
Instructions
Enter formulas to calculate the coefficient of variations then write a comment for part (b).
a. Compute the coefficient of variation for the Shelton Corporation before and after the merger.
Pre-merger Post-merger
Coefficient of variation 0.63 0.40
b. Comment on the possible impact on Shelton’s postmerger P/E ratio, assuming investors are risk-averse.
Risk averse investors are being offered less risk and may assign a higher P/E ratio to postmerger earnings.
Solution
Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 20-11