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Mike,
Why the issue of equity shares by a company as the purchase consideration for the acquisition of a new subsidiary company…. does NOT affect its diluted EPS? (Question 223 on BPP revision kit)
Cannot really understand why as EPS = Profit after tax / shares in issue…. Really strange!
Because, in theory at least, the issue of shares for their market value has no affect on the earnings of the existing shares.
Why?
Because theory suggests that the market price of a share is equal to the value of that share’s future earnings discounted to today
So if you issue a share, the earnings generated by that share are equal to the earnings of the existing shares
And thus there is no dilution of the earnings capacity of those existing shares
When a footballer is transferred from one club to another, you don’t expect the abilities of the existing players to be diminished do you? That new transferee should be equally as capable as the existing players
And that’s how it is with shares … those new shares that were issued in exchange for the acquisition of a subsidiary will be balanced by an increase in the earnings of the group … because now we have the earnings of the subsidiary to add on to the existing earnings
OK?
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