9. Pharmaceutical Acquisitions. During the 1960s many conglomerates were created by a firm enjoying a high price/earnings ratio (P/E). They then used their highly valued stock to acquire other firms that had lower P/E ratios, usually in unrelated domestic industries. These conglomerates went out of fashion during the 1980s when they lost their high P/E ratios, thus making it more difficult to find other firms with lower P/E ratios to acquire. During the 1990s, the same acquisition strategy was possible for firms located in countries where high P/E ratios were common compared to firms in other countries where low P/E ratios were common. Consider the hypothetical firms in the pharmaceuti- cal industry shown in the following table. Pharm-USA wants to acquire Pharm-Italy. It offers 5,500,000 shares of Pharm-USA, with a cur- rent market value of $220,000,000 and a 10% pre- mium on Pharm-Italy's shares, for all of Pharm-Italy's shares.

a. How many shares would Pharm-USA have out- standing after the acquisition of Pharm-Italy?

b. What would be the consolidated earnings of the combined Pharm-USA and Pharm-Italy?

c. Assuming the market continues to capitalize Pharm-USA's earnings at a P/E ratio of 40, what would be the new market value for Pharm-USA?

d. What is the new earnings per share of Pharm- USA?

e. What is the new market value of a share of Pharm-USA?

f. How much did Pharm-USA's stock price increase?

g. Assume that the market takes a negative view of the merger and lowers Pharm-USA's P/E ratio to 30. What would be the new market price per share of stock? What would be its percentage loss?

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Market value P/E ratio Number of shares per share Earnings EPS Total market value Pharm-Italy 20 10,000,000 $20 $10,000,000 $1.00 $200,000,000 Pharm-USA 40 10,000,000 $40 10,000,000 $1.00 $400,000,000