Finance II

Problem Set 8
CLASS 6

Finance II – Fernando Santos Jorge – Spring 2022

 Raider

Finance II – Fernando Santos Jorge – Spring 2022

 Raider
Your company, Raider Plc, has earnings per share of €4. It has one million shares outstanding,
each currently priced at €40. Raider is contemplating the acquisition of TargetCo, which has
earnings per share of €2, one million shares outstanding, and a price per share €25. Raider will
fund the acquisition through the issuance of new shares. There are no expected synergies from
the transaction.
a) If there is no premium paid for the acquisition of TargetCo, what are the expected earnings
per share of Raider after the merger?
b) How would the answer in (a) differ if a 20% premium needs to be paid for the acquisition to
go through?
c) How can you explain the change in earnings per share in part (a)? Are shareholders any
better or worse off?
d) What is the price-earnings ratio of the combined firm after the merger (in the case of no
premium)? How does this compare to the P/E of Raider before the merger? How does this
compare to TargetCo’s pre-merger P/E ratio?

Finance II – Fernando Santos Jorge – Spring 2022

 Raider
Your company, Raider Plc, has earnings per share of €4. It has one million shares outstanding,
each currently priced at €40. Raider is contemplating the acquisition of TargetCo, which has
earnings per share of €2, one million shares outstanding, and a price per share €25. Raider will
fund the acquisition through the issuance of new shares. There are no expected synergies from
the transaction.
a) If there is no premium paid for the acquisition of TargetCo, what are the expected earnings
per share of Raider after the merger?

No premium
€25m
ΔN = = 625000 new shares
€40

#$%&'&()!*#$%&'&()"
𝐸𝑃𝑆 !" = +*,-
=€6m/1.625m=€3.69

Finance II – Fernando Santos Jorge – Spring 2022

 Raider
Your company, Raider Plc, has earnings per share of €4. It has one million shares outstanding,
each currently priced at €40. Raider is contemplating the acquisition of TargetCo, which has
earnings per share of €2, one million shares outstanding, and a price per share €25. Raider will
fund the acquisition through the issuance of new shares. There are no expected synergies from
the transaction.
b) How would the answer in (a) differ if a 20% premium needs to be paid for the acquisition to
go through?

Premium=20%, so we’ll pay 25x1,2=€30m for B

!"# !"#
Therefore, we need: ΔNxP ! = €30m $&.P ! 𝑥(1𝑚 +ΔN)=€65m

!"#
ΔN=857142 $&.P ! =€35 – this should be obvious, because if we
are overpaying €5m for company B, then this amount is coming off of Raider’s equity…

New EPSAB=€6m/1.857m=€3,23

Finance II – Fernando Santos Jorge – Spring 2022

 Raider
c) How can you explain the change in earnings per share in part (a)? Are shareholders any
better or worse off?

This is due to a higher dilution effect we got in sub-question b). The stocks of old shareholders
will be worth less (€35) and they are the ones paying for this premium.

d) What is the price-earnings ratio of the combined firm after the merger (in the case of no
premium)? How does this compare to the P/E of Raider before the merger? How does this
compare to TargetCo’s pre-merger P/E ratio?

€40 €25
𝑃𝐸𝑅 ! = = 10 𝑃𝐸𝑅 " = = 12.5
€4 €2

€$%&€'(
𝑃𝐸𝑅 !" = = 10.83, after the merger, it’s the exact weighted average, because there is no premium.
€)
With premium, what we have is:
€35 + €25
𝑃𝐸𝑅 !" = = 10
€6

Finance II – Fernando Santos Jorge – Spring 2022

 Mac&Cheese

Finance II – Fernando Santos Jorge – Spring 2022

 Mac&Cheese
Mac Plc. and Cheese Inc. are valued as follows:

Company Mac Cheese

Number of shares 2,000 1,000
EPS €10 €10
Stock price €100 €50

Mac moves to acquire Cheese by offering one (newly issued) share for every two shares
of Cheese (i.e., Mac will have 2,500 shares outstanding after the merger).
a) If there are no economic gains from the merger, what is the price-earnings ratio of Mac's
stock after the merger?
Suppose now that the merger really does increase the value of the combined firms by €20,000.
b) What is the cost of the merger?
c) What is the price-earnings ratio of Mac's stock after the merger?

Finance II – Fernando Santos Jorge – Spring 2022

 Mac&Cheese
Mac Plc. and Cheese Inc. are valued as follows:

Company Mac Cheese

Number of shares 2,000 1,000
EPS €10 €10
Stock price €100 €50

Mac moves to acquire Cheese by offering one (newly issued) share for every two shares
of Cheese (i.e., Mac will have 2,500 shares outstanding after the merger).
a) If there are no economic gains from the merger, what is the price-earnings ratio of Mac's
stock after the merger?
ΔN /!0 = 2500 − 2000 = 500 𝑛𝑒𝑤 𝑠ℎ𝑎𝑟𝑒𝑠
𝐸𝑞𝑢𝑖𝑡𝑦 𝑀𝑎𝑐^𝐶ℎ𝑒𝑒𝑠𝑒 €100𝑥2000 + €50𝑥1000
𝑃𝐸𝑅 123$4 = = = €8.3
𝑇𝑜𝑡𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠𝑀𝑎𝑐^𝐶ℎ𝑒𝑒𝑠𝑒 €10𝑥2000 + €10𝑥1000

Finance II – Fernando Santos Jorge – Spring 2022

 Mac&Cheese
Mac Plc. and Cheese Inc. are valued as follows:

Company Mac Cheese

Number of shares 2,000 1,000
EPS €10 €10
Stock price €100 €50

Suppose now that the merger really does increase the value of the combined firms by €20,000.
b) What is the cost of the merger?
If gain=€20k
/!0^0677)7
€100𝑥2000 + €50𝑥1000 + €20000
𝑃 = = €108
2500
Cost= 500𝑥𝑃/!0^0677)7 − 50𝑥1000 = €4,000

c) What is the price-earnings ratio of Mac's stock after the merger?

€9::;<=::*€<::::
New 𝑃𝐸𝑅 /!0^0677)7 = = €9
€9:;<:::*€9:;9:::

Finance II – Fernando Santos Jorge – Spring 2022

 Mino-Taurus

Finance II – Fernando Santos Jorge – Spring 2022

 Mino-Taurus
As treasurer of Mino, you are investigating the possible acquisition of Taurus. You have the
following basic data:
Company Mino Taurus
Next year’s expected EPS €5.00 €1.50
Next year’s expected DPS €3.00 €0.80
Number of shares 1m 0.6m
Stock price €90 €20

You estimate that investors currently expect a steady growth of about 6% in Taurus’ earnings
and dividends. Under new management, this growth rate would increase to 8% per year,
without any additional capital investment required.
a) What is the gain from the acquisition?
b) What is the acquisition cost if Mino pays €25 in cash for each share of Taurus?
c) What is the cost of the acquisition if Mino offers one newly issued share for every three
shares of Taurus?
d) How would the cost of cash bid and the stock bid change if the expected growth rate
of Taurus remained unaffected by the merger?

Finance II – Fernando Santos Jorge – Spring 2022

 Mino-Taurus
As treasurer of Mino, you are investigating the possible acquisition of Taurus. You have the
following basic data:
Company Mino Taurus
Next year’s expected EPS €5.00 €1.50
Next year’s expected DPS €3.00 €0.80
Number of shares 1m 0.6m
Stock price €90 €20

You estimate that investors currently expect a steady growth of about 6% in Taurus’ earnings
and dividends. Under new management, this growth rate would increase to 8% per year,
without any additional capital investment required.
a) What is the gain from the acquisition? 𝑃𝑉1 = €12𝑚
𝐺𝑎𝑖𝑛 = 𝑃𝑉*+ − 𝑃𝑉* − 𝑃𝑉+ €0.8𝑥0.6𝑚𝑠ℎ𝑎𝑟𝑒𝑠
𝑃𝑉* = €90𝑥1,000,000 = €90,000,000 =
𝑃𝑉+ = €20𝑥600,000 = €12,000,000
𝑟 − 6%
𝐷𝑖𝑣 €0.8𝑥0.6𝑚𝑠ℎ𝑎𝑟𝑒𝑠
r=10%
-
𝑃𝑉+, =? = = = €24𝑚
𝑟 − 𝑔, 10% − 8%
∆𝑃𝑉+ = €24𝑚 − €12𝑚 = €12𝑚
𝐺𝑎𝑖𝑛 = €90𝑚 + €24𝑚 − €90𝑚 − €12𝑚 = €12𝑚
Finance II – Fernando Santos Jorge – Spring 2022
 Mino-Taurus
b) What is the acquisition cost if Mino pays €25 in cash for each share of Taurus?
𝐶𝑜𝑠𝑡 = 𝐶𝑎𝑠ℎ 𝑃𝑎𝑖𝑑 − 𝑃𝑉1 = €25𝑥0.6𝑚 − €20𝑥0.6𝑚 = €3𝑚

c) What is the cost of the acquisition if Mino offers one newly issued share for every three
shares of Taurus?
1 share of Mino=€90 for 3 shares of Taurus=3x€20=€60

0.6𝑚
∆𝑁 = = 0.2𝑚 𝑛𝑒𝑤 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑓 𝑀𝑖𝑛𝑜
3
€99>?
𝐶𝑜𝑠𝑡 = ∆𝑁𝑥𝑃/1 − 𝑃1 𝑥𝑁1 = (0.2𝑚𝑥 𝑃/1 ) − €20𝑥0.6𝑚 ⇔ 𝑃/1 = 9.<?)6$%7) = €95

⇒ 𝐶𝑜𝑠𝑡 = 0.2𝑚𝑥€95 − 0.6𝑚𝑥€20 = €7𝑚 (we issue 0.2m share of MT to buy 0.6m share of T)
d) How would the cost of cash bid and the stock bid change if the expected growth rate
of Taurus remained unaffected by the merger?
Cash Cost=€3m Stock Offer Cost=€7m (considering g=8%)
New: Cash Cost=€3m Stock Offer Cost= (0.2𝑚𝑥€85) − €20𝑥0.6𝑚 = €5𝑚
€90𝑚 + €12𝑚
𝑃*+ = = €85
1.2𝑚𝑠ℎ𝑎𝑟𝑒𝑠

Finance II – Fernando Santos Jorge – Spring 2022

 Alentejo Wine Wars

Finance II – Fernando Santos Jorge – Spring 2022

 Alentejo Wine Wars
Alentejo Vinho Tinto (AVT) intends to bid for Alentejo Vinho Verde (AVV). Both companies are all-
equity financed. AVT thinks that by acquiring AVV it will benefit from economies of scale that can cut
€1m in costs per year in perpetuity, starting next year (the relevant annual discount rate is 10%).
Before any bid intention was announced, AVT was trading at €5/share and had ten million shares
outstanding; while AVV was trading at €10/share and had two million shares outstanding.
a) What are the synergies of the potential merger between AVT and AVV?
b) What is the maximum price AVT would be willing to offer in exchange for a share of AVV in a cash
bid?
c) In a stock bid, what is the maximum number of new shares that AVT would be willing to issue and
offer in exchange for all the shares of AVV? What would be the stock price of the merged
company right after the merger?
d) Suppose instead that the entire bargain power is on the side of AVT (i.e. all synergies accrue to
AVT’s original shareholders). What is the number of new shares to be issued and offered
in exchange for all the shares of AVV shares? What is the stock price of the merged company right
after the merger?
e) Consider now that there has been a misevaluation of the annual savings, so large that a merger
would in fact be reducing cash flows from current operations rather
than creating cost synergies. Can you think of other reasons why AVT would be willing to go ahead
and bid for AVV?

Finance II – Fernando Santos Jorge – Spring 2022

 Alentejo Wine Wars
Alentejo Vinho Tinto (AVT) intends to bid for Alentejo Vinho Verde (AVV). Both companies are all-
equity financed. AVT thinks that by acquiring AVV it will benefit from economies of scale that can cut
€1m in costs per year in perpetuity, starting next year (the relevant annual discount rate is 10%).
Before any bid intention was announced, AVT was trading at €5/share and had ten million shares
outstanding; while AVV was trading at €10/share and had two million shares outstanding.
a) What are the synergies of the potential merger between AVT and AVV?
Synergies: €1M/0.1 = € 10M
b) What is the maximum price AVT would be willing to offer in exchange for a share of AVV in a cash
bid?
Synergies per share = €5 = €10M / 2 million shares. So, maximum is = €5 + €10 = €15
c) In a stock bid, what is the maximum number of new shares that AVT would be willing to issue and
offer in exchange for all the shares of AVV? What would be the stock price of the merged
company right after the merger?
The new merged company is going to be worth €5*10M + €10*2M +€10M= €80M

If AVT’s shareholders don’t want to lose money, they have to have at least €50M worth of shares in
the merged company after the merger. This means that 10M*P = €50M, hence P=€5.
Since, ΔN*€5 = €30M, then ΔN= 6M new shares that are going to be issued at the merged company in
exchange for all AVV’s shares.

Finance II – Fernando Santos Jorge – Spring 2022

 Alentejo Wine Wars
d) Suppose instead that the entire bargain power is on the side of AVT (i.e. all synergies accrue
to AVT’s original shareholders). What is the number of new shares to be issued and offered
in exchange for all the shares of AVV shares? What is the stock price of the merged
company right after the merger?
The new merged company is going to be worth €5*10M + €10*2M +€10M= €80M

If AVT’s shareholders have all the bargaining power, they have to have, at least €60M worth of shares
in the merged company after the merger, which means 10M*P = €60M, hence P=€6.
Then, since ΔN*€6 = €20M, it must be that ΔN= 3.33M new shares are going to be issued at the
merged company in exchange for all AVV’s shares.

e) Consider now that there has been a misevaluation of the annual savings, so large that a
merger would in fact be reducing cash flows from current operations rather
than creating cost synergies. Can you think of other reasons why AVT would be willing to
go ahead and bid for AVV?

Mergers can go ahead even if there is destruction of value. However the cost of the bid should be
negative.

Finance II – Fernando Santos Jorge – Spring 2022