Corporate Governance: Overstating Earnings. During the 1960s, many conglomerates were created by firms that were enjoying a high pricelearnings ratio (P/E). These firms then used their highly valued stock to acquire other firms that had lower P/E ratios, usually in unrelated domestic industries. 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 pharmaceutical industry shown in the table below. (Click on the icon to import the table into a spreadsheet.) Modern American wants to acquire ModoUnico. It offers 5,500,000 shares of Modern American, with a current market value of $220,000,000 and a 10% premium on ModoUnico's shares, for all of ModoUnico's shares. Number Market value Total Company P/E ratio of shares per share Earnings EPS Market Value ModoUnico 10,000,000 $22.00 $10,000,000 $1.00 $220,000,000 Modern American 44 10,000,000 $44.00 $10,000,000 $1.00 $440,000,000 a. How many shares would Modern American have outstanding after the acquisition of ModoUnico? b. What would be the consolidated earnings of the combined Modern American and ModoUnico? c. Assuming the market continues to capitalize Modern American's earnings at a P/E ratio of 44, what would be the new market value of Modern American? d. What would be the new earnings per share of Modern American? e. What would be the new market value of a share of Modern American? f. How much would Modern American's stock price increase? g. A number of firms, especially in the United States, have had to lower their previously reported earnings due to accounting errors or fraud. Assume that Modern American had to lower its earnings to $5,000,000 from the previously reported $10,000,000. What might be its new market value prior to the acquisition? Could it still do the acquisition? 22 a. How many shares would Modern American have outstanding after the acquisition of ModoUnico? The new number of shares would be (Round to the nearest integer.) b. What would be the consolidated earnings of the combined Modern American and ModoUnico? The consolidated earnings would be $ (Round to the nearest dollar.) C. Assuming the market continues to capitalize Modern American's earnings at a P/E ratio of 44, what would be the new market value of Modern American? The new value of Modern American would be $ (Round to the nearest dollar.) d. What would be the new earnings per share of Modern American? The new earnings per share would be $ (Round to the nearest cent.) e. What would be the new market value of a share of Modern American? The new market value of a share would be s (Round to the nearest cent.) f. How much would Modern American's stock price increase? The change in the stock price would be %. (Round to two decimal places.) g. A number of firms, especially in the United States, have had to lower their previously reported earnings due to accounting errors or fraud. Assume that Modern American had to lower its earnings to $5,000,000 from the previously reported $10,000,000. What might be its new market value prior to the acquisition? The new market value prior to the acquisition would be $ (Round to the nearest dollar.) The new market value per share prior to the acquisition would be $ (Round to the nearest cent.) shares. (Round to the nearest integer.) To do the deal, ModoUnico's shareholders would need to be paid Could it still do the acquisition? (Select the best choice below.) O A. These 11,000,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably take place anyway. OB. These 10,450,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably not take place. O C. These 10,450,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably take place anyway. OD. These 11,000,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably not take place. Corporate Governance: Overstating Earnings. During the 1960s, many conglomerates were created by firms that were enjoying a high pricelearnings ratio (P/E). These firms then used their highly valued stock to acquire other firms that had lower P/E ratios, usually in unrelated domestic industries. 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 pharmaceutical industry shown in the table below. (Click on the icon to import the table into a spreadsheet.) Modern American wants to acquire ModoUnico. It offers 5,500,000 shares of Modern American, with a current market value of $220,000,000 and a 10% premium on ModoUnico's shares, for all of ModoUnico's shares. Number Market value Total Company P/E ratio of shares per share Earnings EPS Market Value ModoUnico 10,000,000 $22.00 $10,000,000 $1.00 $220,000,000 Modern American 44 10,000,000 $44.00 $10,000,000 $1.00 $440,000,000 a. How many shares would Modern American have outstanding after the acquisition of ModoUnico? b. What would be the consolidated earnings of the combined Modern American and ModoUnico? c. Assuming the market continues to capitalize Modern American's earnings at a P/E ratio of 44, what would be the new market value of Modern American? d. What would be the new earnings per share of Modern American? e. What would be the new market value of a share of Modern American? f. How much would Modern American's stock price increase? g. A number of firms, especially in the United States, have had to lower their previously reported earnings due to accounting errors or fraud. Assume that Modern American had to lower its earnings to $5,000,000 from the previously reported $10,000,000. What might be its new market value prior to the acquisition? Could it still do the acquisition? 22 a. How many shares would Modern American have outstanding after the acquisition of ModoUnico? The new number of shares would be (Round to the nearest integer.) b. What would be the consolidated earnings of the combined Modern American and ModoUnico? The consolidated earnings would be $ (Round to the nearest dollar.) C. Assuming the market continues to capitalize Modern American's earnings at a P/E ratio of 44, what would be the new market value of Modern American? The new value of Modern American would be $ (Round to the nearest dollar.) d. What would be the new earnings per share of Modern American? The new earnings per share would be $ (Round to the nearest cent.) e. What would be the new market value of a share of Modern American? The new market value of a share would be s (Round to the nearest cent.) f. How much would Modern American's stock price increase? The change in the stock price would be %. (Round to two decimal places.) g. A number of firms, especially in the United States, have had to lower their previously reported earnings due to accounting errors or fraud. Assume that Modern American had to lower its earnings to $5,000,000 from the previously reported $10,000,000. What might be its new market value prior to the acquisition? The new market value prior to the acquisition would be $ (Round to the nearest dollar.) The new market value per share prior to the acquisition would be $ (Round to the nearest cent.) shares. (Round to the nearest integer.) To do the deal, ModoUnico's shareholders would need to be paid Could it still do the acquisition? (Select the best choice below.) O A. These 11,000,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably take place anyway. OB. These 10,450,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably not take place. O C. These 10,450,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably take place anyway. OD. These 11,000,000 shares would exceed Modern American's existing shares outstanding, effectively giving ModoUnico control. Therefore the acquistion would probably not take place