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The following information relates to two companies, Alpha plc and Beta plc
Alpha plc
Earnings after tax $210,000
P/E ratio 16Beta plc
Earnings after tax $900,000
P/E ratio 21Beta plc’s management estimate that if they were to acquire Alpha plc they could save
$100,000 annually after tax on administrative costs in running the new joint company.
Additionally, they estimate that the P/E ratio of the new company would be 18.On the basis of these estimates, what is the maximum that the shareholders of Beta plc
should pay for the entire share capital of Alpha plc?A $1.1m
B $2.9m
C $4.2m
D $2.0mSolution:
Value of Alpha and Beta combined (210 + 900 + 100) × 18 = 21,780
Value of Beta on its own 900 × 21= (18,900)
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Maximum value of Alpha= 2,880Why are we calculating the value of the joint company when they’ve asked to calculate the maximum the shareholders of Beta co should pay for the entire share capital of ALPHA CO??
After the acquisition there is only Beta, and if the could take over Alpha without paying anything then the shareholders of Beta would be worth an extra 2,880.
Obviously they will have to pay something for Alpha, but the most they will pay (without being worse off) is 2,880.
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