Chapter 20, Problem 7P

a.

Summary Introduction

To calculate: The price paid by Jeter Corp. to A-Rod’s Corp.

Introduction:

Merger:

An agreement between two existing companies that combines them to form a single company is termed as a merger. This is done for the expansion of business, share in the market, and value of shareholders.

Answer to Problem 7P

The price paid by Jeter Corp. to A-Rod’s Corp. is $48.

Explanation of Solution

Calculation of the price paid by the Jeter Corp.:

$\begin{array}{c}\text{Price paid}=\text{Current Price}\times \text{6}0\%\text{Premium }\\ =\$30\times \left(1+60\%\right)\\ =\$30\times \left(1.60\right)\\ =\$48\end{array}$

b.

Summary Introduction

To calculate: The total market value of A-Rod Corp. at the price computed in part (a).

Introduction:

Market Value:

It is a term used to define the worth of an item according to the market participants and can be affected by fluctuations in market demand and supply.

Answer to Problem 7P

The total market value of A-Rod Corp. is $19,200,000

Explanation of Solution

Calculation of the market value:

$\begin{array}{c}\text{Total Market Value}=\text{Price Paid}\times \text{No}\text{. of shares outstanding}\\ =\$48\times 400,000\\ =\$19,200,000\end{array}$

c.

Summary Introduction

To calculate: The P/E ratio assigned by Jeter Corp. to A-Rod Corp. at the price computed in part (a).

Introduction:

P/E ratio:

It is calculated by dividing the current share price of a company by its EPS. It helps in valuing the the present as well as future profitability of a company.

Answer to Problem 7P

The P/E ratio of A-Rod Corp. assigned by Jeter Corp. is 19.2.

Explanation of Solution

Calculation of the P/E ratio of A-Rod Corp.:

$\begin{array}{c}\text{P/E Ratio}=\frac{\text{Price}}{\text{Earning Per Share}}\\ =\frac{\$48}{\$2.50}\\ =19.2\end{array}$

d.

Summary Introduction

To calculate: The number of shares required to be issued by Jeter Corp. to buy A-Rod Corp. at the total market value computed in part (b).

Introduction:

Share Price

The highest price of one share of a company that an investor is willing to pay is termed as the price of the share. It is the current price used for the trading of such shares.

Market Value:

It is a term used to define the worth of an item according to the market participants and can be affected by fluctuations in market demand and supply.

Answer to Problem 7P

The number of shares required to be issued by Jeter Corp. to buy A-Rod Corp. is 640,000.

Explanation of Solution

Calculation of the shares issued by Jeter Corp.:

$\begin{array}{c}\text{New Shares}=\frac{\text{Total Market Value of A-Rod Corp}\text{.}}{\text{Jeter Corp}\text{.'s share price}}\\ =\frac{\$19,200,000}{\$30}\\ =640,000\end{array}$

e.

Summary Introduction

To calculate:The total number of shares Jeter Corp. will have after the merger.

Introduction:

Merger:

An agreement between two existing companies that combines them to form a single company is termed as a merger. This is done for expansion of business, share in the market, and value of shareholders.

Answer to Problem 7P

The number of shares Jeter Corp. will have after the merger is 2,640,000.

Explanation of Solution

Calculation of the number of shares Jeter Corp. have after the merger:

$\begin{array}{c}\text{Post Merger shares}=\text{Old Shares}+\text{New Shares}\\ =2,000,000+640,000\\ =2,640,000\end{array}$

f.

Summary Introduction

To calculate: The new post-merger earnings per share.

Introduction:

Earnings per share:

It is the profit per outstanding share of a public company. A higher EPS indicates a higher value of the company because investors are ready to pay a higher price for one share of the company. 

Answer to Problem 7P

The new post-merger earnings per share of the corporation is $1.89.

Explanation of Solution

Calculation of the new post-merger earnings per share (EPS):

$\begin{array}{c}\text{New post-merger}\left(\text{EPS}\right)=\frac{\text{Total Earnings}}{\text{Total Shares}}\\ =\frac{\$5,000,000}{2,640,000}\\ =\$1.89\end{array}$

Working Note:

Calculation of total earnings:

$\begin{array}{c}\text{Total Earnings}=\text{A-Rod Earnings}+\text{Jeter Corp}\text{. Earnings}\\ =\$1,000,000+\$4,000,000\\ =\$5,000,000\end{array}$

g.

Summary Introduction

To explain: The reason that the EPS of Jeter Corp. has gone down.

Introduction:

Earnings per share:

It is the profit per outstanding share of a public company. A higher EPS indicates a higher value of the company because investors are ready to pay a higher price for one share of the company. 

Answer to Problem 7P

The EPS of Jeter Corp. has gone down because it has paid a higher P/E ratio, that is, 19.2, for A-Rod Corp. than the P/E ratio it has paid for its own shares.

Explanation of Solution

Whenever a company pays higher P/E ratio as compared to its own, it will cause a dilution in the EPS of the company. Thus, the reason for the dilution of EPS of Jeter Corp. is the payment of the P/E ratio for A-Rod Corp., which is higher than what it paid to its own shareholders.

h.

Summary Introduction

To explain: The way in which Jeter Cop. overcomes its dilution of EPS.

Introduction:

Earnings per share:

It is the profit per outstanding share of a public company. A higher EPS indicates a higher value of the company because investors are ready to pay a higher price for one share of the company. 

Answer to Problem 7P

Jeter Cop. overcomes its dilution of earnings per share through rapid future growth of earnings.

Explanation of Solution

Rapid growth of revenue and earnings is the best practice followed by companies for the prevention of dilution of EPS, which tempts them to invest a large amount for fast growth. Thus, Jeter Corp. shall increase its EPS and overcome the dilution of the same.