Question

Metro ltd is considering the acquisition of Ace ltd. Metros price-earnings ratio is 16 and it has 8 million ordinary shares in issue. Its after-tax earnings amounts to N$8 million per annum. Ace ltd has a price-earnings ratio of 12 and has an issued ordinary share capital of 2 million shares. Aces after- tax earnings amounts to N$6 million per annum. Earnings and dividends of Ace Ltd are expected to grow at a constant rate of 10% per annum, without the merger. The merger is expected to increase the growth rate in Ace Ltds earnings and dividends to 12% per annum. Ace has a current dividend cover of two. Metro Ltds tax rate is 28%. The merger will result in an immediate increase, due to synergy, in after-tax earnings of N$1 million per annum. Metros shareholders, based on the level of risk involved in Ace, require a return of 16% per annum from any investment in Ace Ltd.

Required: a) What value would Metro place on each share in Ace Ltd? b) Metro is considering offering 5.5 million of its shares in exchange for ordinary shares in Ace Ltd. What is the immediate effect on the earnings per share of Metro and Ace shareholders? c) Metro is considering a cash offer of N$43 per share in Ace. Metro can borrow at 14% per annum to finance the cash offer. How would this option impact on Metros current earnings per share after the merger? Indicate whether you would recommend a cash offer or a share offer.