Currently, Firm C has earnings per share (EPS) of $4 (per year) and has 1 million shares outstanding. Its price to earnings (P/E) ratio is 15. Firm D also has EPS of $4, has 3 million shares outstanding, and its P/E is 20. Firm D has just made an equity offer for Firm C, offering to exchange each share in Firm C for three-quarters'shares in the merged firm. However, because of possible clashes in the culture of the two firms, Firm D's management anticipates a loss of 5% of all cash flows (and hence earnings) at the target, although no change to the anticipated growth rate over time (so no change in the target's P/E ratio).

 

1) If the merger is approved, what will be the combined firm's EPS? What percent increase (or decrease) does this represent?

 

2) If the merger is approved, what will be the combined firm's per share value?

 

3) Should Firm D pursue this merger at the proposed terms?