Question

Companies A and B are valued as follows:
	A	B
# of shares	2,000	1,000
Earnings per share	$               20	$             10
Share price	$             100	$             75
Given that the price-earnings ratio of Company B is 50% larger than the price-earnings ratio of Company A, would it be reasonable for Company A to pay a premium of 50% to acquire the shares of Company B? Please explain your answer.

Answer 1

Companies A and B are valued as follows:
	A	B
No of shares	2,000	1,000	------A
Earnings per share	20	10	------B
Share price	100	75	------C
Market value of shares	200000	75000
Total earnings	40000	10000
PE ratio computed	5	7.5
When company b is acquired PE ration of b will be reduced to 5
Combined earnings	50000
Combined value of firm basis earnings	250000
Combined value of firm market capitalisation	275000
Loss in value to due take over	25000
value of 1 share of A	100
Total Extra shares issue to compensate for the loss	250	--------A
Value of Firm B	75000
Share price per share of A	100
No of shares	750	--------B
Total shares to be issued	1000
hence a total of 1000 shares of A should be issued to B and not 1500 shares