Problem: ABC is evaluating a proposed merger into DEF. ABC had 2009 earnings of $200,000, has 100,000 shares of common stock outstanding, and expects earnings to grow at an annual rate of 7%. DEF had 2009 earnings of $800,000, has 200,000 shares of common stock outstanding, and expects its earnings to grow at 3% per year.
(Q1) Calculate the expected earnings per share (EPS) for ABC for each of the next five years (2010-2014) without the merger.
(Q2) What would ABC's stockholders earn in each of the next 5 years (2010-2014) on each of their ABC shares swapped for DEF shares a a ratio of (i) 0.6 shares and (ii) 0.8 shares of DEF for one share of ABC?
(Q3) Graph the pre-merger and post-merger EPS figures developed in parts (a) and (b) with the year on the x axis and the EPS on the y axis.
(Q4) If you were the financial manager for ABC, which would you recommend from part (b): (i) or (ii)? Explain your answer.