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ACCA Strategic Professional · Advanced Financial Management · Financing acquisitions and mergers

Epsilon plc has 5 million shares, earnings $10 million, and market-value equity $100 million with debt of $50 million. It acquires Zeta for $40 million, financed by new 10% debt (tax 20%), and Zeta contributes earnings before interest and tax of $6 million. Epsilon's existing earnings are after tax and interest. Using market-value gearing as debt/equity, what are the post-acquisition EPS and the gearing ratio, assuming equity value stays $100 million?

Net added earnings are $4.8 million less $3.2 million after-tax interest, so earnings rise to $11.6 million and EPS to $2.32. Debt rises to $90 million against $100 million equity, so gearing is 90%. EPS improves while financial risk rises.

  1. AEPS $2.64; gearing 90%Correct
  2. BEPS $2.64; gearing 50%
  3. CEPS $2.00; gearing 90%
  4. DEPS $2.64; gearing 140%

Explanation

Zeta after-tax profit = 6 x 0.8 = 4.8m. After-tax interest = 4m x 0.8 = 3.2m... interest 40m x 10% = 4m, after tax 3.2m. Net addition = 1.6m; earnings 11.6m; EPS = 2.32. Gearing = (50+40)/100 = 90%.

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