Question

1) Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is trading at $20 per share. Rearden Metal is thinking of buying Associated Steel, which has earnings per share of $1.25, 4 million shares outstanding, and a price per share of $15. Rearden Metal will pay for Associated Steel by issuing new shares. There are no expected synergies from the transaction. Assume Rearden offers an exchange ratio such that, at current pre-announcement share prices for both firms, the offer represents a 20% premium to buy Associated Steel.

1. What is the actual premium Rearden will pay?
2. Is this an accretive or dilutive deal?
3. Compare the PE ratio before and after acquisition for Rearden. How does the change in PE ratio relates to your answer to the previous question?

Answer 1

A. Premium payable

1 Rearden Metal 2 Earnings per share 3 Number of shares 4 Price per share 5 6 Total Value of equity of company 10,000,000 $20 $200,000,000 =B4*B3 $1.25 4,000,000 $15 8 Associated Steel 9 Earnings per share 10 Number of shares 11 Price per share 12 13 Total Value of equity of company 14 15 a) Premium payable 16 $60,000,000 =B11*B10 $12,000,000 =B13*0.2

The premium payable will be $12 million. The total value to be paid to Associated Steel's Shareholders will be $72 million

B) The EPS of the company is reduced after acquisition, so this is a dilutive deal

17 b) 18 Total Earnings after acquisition will be the sum of Earnings of the two companies 19 Earnings of a company is calculated by multiplying EPS with number of shares 20 21 Earnings of Rearden Metal $20,000,000 =B2*B3 22 Earnings of Associated Steel $5,000,000 =B9*B10 23 Total Earnings after Acquisition $25,000,000 =SUM(B21:B22) 24 25 Earnings per share after Acquisition $1.84 =B23/B39

The EPS of the company before the acquisition was $2

C)

C D E 26 ) 27 P/E Before Acquisition 10 =B4/B2 28 29 Total Value paid to Associated Steel's Shareholders will be the total value of the company and 30 the 20% premium 31 32 Total Value paid $72,000,000 =B13+B15 33 34 You will get the number of shares issued when you divide the total value paid with the market 35 price of one Rearden Metal share 36 37 Number of new shares issued 3,600,000 =B32/B4 38 39 Total number of shares after acquisition 13,600,000 =B37+B3 40 41 Total value of the combined company after the acquistion will be the sum of value of the two 42 original companies 43 44 Total value of the combined company $260,000,000 =B13+B6 45 46 Price per share of combined company will be the total value of the combined company divided 47 the total number of shares after acquisition 48 49 Price per share of combined company $19.12 =B44/B39 50 Earnings per share after acquisition $1.84 Caculated above 51 52 P/E Ratio is calculated by dividing Price per share with EPS 54 P/E After Acquisition 10.4 =B49/850

The PE ratio increased from 10 to 10.4.

Here the PE of Rearden Metal (10) is lower than the PE of Associated Steel (12). If the Acquiror's PE is lower than the PE of the target, the deal is going to be dilutive