High PE Ratio Target Company
High
PE Ratio Company of Target Company would lower the EPS of the acquiring
company, and therefore market price is expected to fall by such acquisition.
This concept has been explained with example
High PE Ratio Target Company Example
A
acquired B shares Information
of Acquirer
No of
issued Shares= 3,000,000
Market
Price = 6
Annual
Earning= 600,000
EPS = .2
PE
Ratio= 30
Information
of Target Company
No of
issued Shares= 200000
Market
Price =
Annual
Earning= 70,000
EPS =
.35
PE
Ratio=
A
offering two share for each share of b, calculate the PE ratio of target
company and impact of acquisition on EPS of acquiring company.
Solution
Market
value of B Share = 2 share of A x Market price of A share
= 2x6
=12 (market Value of share B)
PE Ratio
= Market Price/EPS
= 12/.35
=34 (P/E Ratio of Company B)
Number
of share to be issued = 200,000 x 2= 400,000
Profit No of Share
Company A 600,000 3,000,000
Company B 70,000 400,000
Total 670,000 3,400,000
EPS of A after acquisition = 670,000/3400000
=.197 (EPS after acquisition)
Market
Price = .197 x 30=5.91
Above
example shows that a high PE ratio company acquired i.e. 34, which lowered the
EPS and market price of the acquiring company. This dilution of EPS may not be
acceptable to the equity holder.
