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ACCA Strategic Professional · Advanced Financial Management · Acquisitions and mergers versus other growth strategies

Zeta plc has 10m shares at $5.00 and earnings of $4m, so its P/E is 12.5. It will acquire Yarn Ltd, with earnings of $1.5m, by issuing new shares at Zeta's price, paying Yarn's owners $12m of shares (2.4m shares). No synergies arise and the combined P/E is assumed to stay at 12.5. What is the combined EPS and the effect on Zeta's EPS (original EPS $0.40)?

Combined EPS is about $0.4435, up from $0.40. Combined earnings are $5.5m over 12.4m shares. Zeta buys Yarn at a P/E of 8 using shares valued on a P/E of 12.5, so EPS rises through the bootstrap effect, not because of real value creation.

  1. AEPS rises to $0.4435, an increase, because Yarn is bought on a P/E of 8Correct
  2. BEPS stays at $0.40 because the P/E is unchanged
  3. CEPS falls to $0.3548 because new shares dilute earnings
  4. DEPS rises to $0.4583 because Yarn's earnings exceed its cost

Explanation

Combined earnings = 4 + 1.5 = $5.5m; shares = 10 + 2.4 = 12.4m; EPS = 0.4435. Yarn's price of $12m on earnings of $1.5m is a P/E of 8, below Zeta's 12.5, so EPS rises (a bootstrap effect). $0.4583 uses 12m shares, which is wrong; $0.3548 is 4.4/12.4 and misuses earnings.

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