Post-merger EPS. Test your knowledge!

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The proposed merger is structured as a stock purchase, in which the shareholders of Durable Parts receive shares of Riley Industries’ common stock. The proposed exchange ratio is 1:1, meaning that for every Durable Parts share owned, shareholders will receive one share of Riley Industries.
Riley Industries Durable Parts Riley – Post Merger
Stock Price $50.00 $10.00 $50.00
EPS $3.50 $2.25
P/E Ratio 14.29 4.44
Total shares o/s 9,000,000 3,000,000
Question: Given the above information, the post-merger EPS of Riley Industries is closest to:
A) $3.98
B) $3.04
C) $3.19
What say ye? I will post answer after I get some responses so that we have a good basis for the discussion to follow.
 
Riley Earnings = 3.5 P/E x 9,000,000 shares = 31.5mil
Durable Earnings = 2.25 P/E x 3,000,000 shares = 6.750 mil
Total Earnings of combined company = $38,250,000 million
Durable Market Cap = $10/share x 3,000,000 shares = $30,000,000
New shares issued = $30,000,000/$50 (Riley’s stock) = 600,000 new shares
Total new shares of new company = 9,600,000
EPS = $38,250,000/9,600,000 = $3.98
 
if I’m not mistaken, you can get A here without doing any math. Since a high P/E firm is acquiring a lower P/E firm post merger EPS has to go up (boostrapping earnings)
 
To those who answered, why? I get how you do the calculation, what I’d like to know is why you did this calculation when the facts to the question state:
“The proposed exchange ratio is 1:1, meaning that for every Durable Parts share owned, shareholders will receive one share of Riley Industries. ”
PS The correct answer is in fact A.
 
Yes, I get that the firm is bootstrapping jut, and I was going to put A until I read that for “every Durable Parts share owned, shareholders will receive one share of Riley Industries” this to me means that if I have one share of Durable I get one share of Riley, not one fifth of a share.
 
they are not getting 1/5 of a share. Riley’s shares are worth more.
so Durable is getting acquired, hence it’s equity ceases to exist. The value of that equity is $10 * 3,000,000 = $30,000,000.
since Rileys shares are worth $50, they have to issue 600 k to fund the acquisition.
 
Don’t think about the share price. Think of the market cap as the 1:1 ratio.
So for the $30mil market cap of Durable they will get 30mil share worth of market cap of Rileys.
 
What do you mean they aren’t getting a 1/5th of a share, by definition they are since their 3MM shares is being replaced with 600K =600/3000=1/5 (right?).
I understand what you are saying in that the 3MM shares have a MV of 30MM, which is the same MV that 600K shares of Riley have. But the question is saying that if you hold 1 share of Durable you get 1 share of Riley, not that if you hold the MV of 1 share of Riley (in terms of Durable stock, which would have to be 5 shares) do you get 1 share of Riley.
Having looked through the CFAI texts (which is what I read) I never had this problem because the institute never used this stupid a$$ notation or confusing description. They always said something like “the offer is to pay the [target name here] shareholders the current market value of their stock in [acquirer stock]” CFAI Vol. 3, Pg. 284. Note how this wording focuses on a 1:1 exchange of market value and not shares as does the Schweser question.
PS I have just about had it with Schweser! Too many mistakes, and A LOT of stuff that wasn’t covered in the CFAI curriculum (at least in the questions)!
 
@BiPolar: that’s fine and great and all if they tell me in the question that they want me to think of it that way (or even if they just say 1:1 and add say nothing else), but they go out of their way to tell me to think of it in terms of shares not MV!
 
adavydov7 Wrote:
——————————————————-
> What do you mean they aren’t getting a 1/5th of a
> share, by definition they are since their 3MM
> shares is being replaced with 600K =600/3000=1/5
> (right?).
>
> I understand what you are saying in that the 3MM
> shares have a MV of 30MM, which is the same MV
> that 600K shares of Riley have. But the question
> is saying that if you hold 1 share of Durable you
> get 1 share of Riley, not that if you hold the MV
> of 1 share of Riley (in terms of Durable stock,
> which would have to be 5 shares) do you get 1
> share of Riley.
>
> Having looked through the CFAI texts (which is
> what I read) I never had this problem because the
> institute never used this stupid a$$ notation or
> confusing description. They always said something
> like “the offer is to pay the shareholders the
> current market value of their stock in ” CFAI Vol.
> 3, Pg. 284. Note how this wording focuses on a 1:1
> exchange of market value and not shares as does
> the Schweser question.
>
> PS I have just about had it with Schweser! Too
> many mistakes, and A LOT of stuff that wasn’t
> covered in the CFAI curriculum (at least in the
> questions)!
I’m with you adavydov, I have run into a few questions like this as well and they seem to do nothing but confuse me…had I seen this question on test day, I would have put c.
Best,
TheChad
 
dude relax. Just remember this from now on. Chances are they’ll prob ask this question and tell you its all financed by all equity or debt in which case for equity it will be calculated the same and for debt you’ll have to subtract the after tax cost of debt from earnings.
 
@BiPolar: can’t man, I am freaking stressing!! And sh!t like this doesn’t help. I mean these are freaking softball questions that no one has any business missing!
 
oh I see what you’re saying. yeah I guess you’re right. I didn’t even realize that, I just saw 1 for 1 and assumed that just meant there was no premium over market.
but like has been said, you don’t have to worry about that on exam day, CFA actually puts time and energy into there questions to avoid this kind of ambiguity.
 
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