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Sir, in Mar/Jun 16 question 3, part c,
1)In calculation of gearing post acquisition, the answer model has used the new earnings per share * number of shares * P/E ratio
If I was to calculate the share price of the combined company including the synergy, would that be OK?
I am getting a difference in answer of 0.4 percent.
2) In the question, we assume that surplus will be invested at the rate of 5 percent pre tax. The current tax rate is 20 percent by taking a percent of tax on PBT, then why in eps calculation, do we not include the the 5 percent gain on cash available?
Thanks
1. The answer is calculating the share price including the synergy, assuming that the PE ratio remains unchanged (as per the question).
2. PE ratios are applied to current earnings – not future earnings.
1) So if the P/E was to change post acquisition, then we would use the combined company valuation technique?
2) Then in the answer, for option b and c, they include the interest cost plus the opportunity cost as well. Why is that?
1. You would apply the new PE to the new earnings.
2. I don’t understand your question.
What I was saying that in 2 that the part c of the question, the company has an option to take the loan at pretax of 7.5% and deposit the excess at 5%.
In share for share option will have cash with the firm and would be assumed to be to be invested which would earn 5% annually.
But in the answer, they have ignored the investment.
Also, in the cash option and mix option of share plus cash, they have included the effect of loan interest and also have included the opportunity cost of the 5% interest which could have been gained on the amount of cash held
My question was, why isn’t the the 5% receipt shown in the calculation of Eps when we can show it as opportunity cost in the other 2 options?
Opportunity cost doesn’t seem to be relevant here. Why do we include this?
Thanks
And, why do we include the opportunity cost
They will only take debt funding needed to complete the acquisition (as per the question) – they would be mad to borrow money at 7.5% if all they were going to do with it was to invest it at 5% 🙂
Cash raised from borrowing is costing them 7.5%, using existing cash is costing them 5% (that is currently being earned, but will not be earned if the cash is used).
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