Question

Bootstrapping earnings. Assume that Firm 1 issues additional shares to buy Firm 2 In scenario A, assume that the market applies the pre-merger P/E of Firm 1 to post-merger earnings In Scenario B, assume that the market applies the weighted average P/E to the post-merger company. *Weighted average P/E is calculated by multiplying PE of each firm by its share of combined earnings and summing the two results Firm 2 Firm 1 A В $200 $80 Earnings Number of shares 100 80 120 120 $2 $1 Earnings per share P/E 20 10 20 $40 $10 Price per share Market value of $4,000 $800 stock

Answer 1

	firm 1	firm 1	A	B
Earnings	$200	$80	$280	$280
No of shares	100	80	120	120
Earning per share	$2	$1	$2.33	$2.33
p/e	20	10	20	17
price per share	$40	$10	$46.67	$39.61
Market value of stock	$4000	$800	$5600	$4753

Weighted PE ratio is Calculated by Multiplying PE of each firm by share of its combined earnings

= ( PE of firm 1 * earnings of firm 1 / combined earnings ) + ( PE of firm 2 * earnings of firm 2 / combined earnings )

=(20*200/280)+(10*80/280)

=14.29+2.86

=17.15(Rounded to 17)