Principles of Corporate Finance_ 12th Edition

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840 Part Ten Mergers, Corporate Control, and Governance


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b. “Merge with Fledgling Electronics? No way! Their P/E’s too high. That deal would knock
20% off our earnings per share.”
c. “Our stock’s at an all-time high. It’s time to make our offer for Digital Organics. Sure,
we’ll have to offer a hefty premium to Digital stockholders, but we don’t have to pay in
cash. We’ll give them new shares of our stock.”


  1. Merger gains and costs Sometimes the stock price of a possible target company rises in
    anticipation of a merger bid. Explain how this complicates the bidder’s evaluation of the tar-
    get company.

  2. Merger motives Suppose you obtain special information—information unavailable to
    investors—indicating that Backwoods Chemical’s stock price is 40% undervalued. Is that a
    reason to launch a takeover bid for Backwoods? Explain carefully.

  3. Merger gains and costs As treasurer of Leisure Products, Inc., you are investigating the
    possible acquisition of Plastitoys. You have the following basic data:


Leisure Products Plastitoys

Earnings per share $5.00 $1.50
Dividend per share $3.00 $0.80
Number of shares 1,000,000 600,000
Stock price $90 $20

You estimate that investors currently expect a steady growth of about 6% in Plastitoys’ earn-
ings and dividends. Under new management this growth rate would be increased to 8% per
year, without any additional capital investment required.
a. What is the gain from the acquisition?
b. What is the cost of the acquisition if Leisure Products pays $25 in cash for each share of
Plastitoys?
c. What is the cost of the acquisition if Leisure Products offers one share of Leisure Products
for every three shares of Plastitoys?
d. How would the cost of the cash offer and the share offer alter if the expected growth rate
of Plastitoys were not changed by the merger?


  1. The bootstrap game The Muck and Slurry merger has fallen through (see Section 31-2).
    But World Enterprises is determined to report earnings per share of $2.67. It therefore
    acquires the Wheelrim and Axle Company. You are given the following facts:


World Enterprises Wheelrim and Axle Merged Firm
Earnings per share $2.00 $2.50 $2.67
Price per share $40 $25?
Price–earnings ratio 20 10?
Number of shares 100,000 200,000?
Total earnings $200,000 $500,000?
Total market value $4,000,000 $5,000,000?

Once again there are no gains from merging. In exchange for Wheelrim and Axle shares, World
Enterprises issues just enough of its own shares to ensure its $2.67 earnings per share objective.
a. Complete the above table for the merged firm.
b. How many shares of World Enterprises are exchanged for each share of Wheelrim and Axle?
c. What is the cost of the merger to World Enterprises?
d. What is the change in the total market value of the World Enterprises shares that were
outstanding before the merger?
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