Question: Fashion Acquisitions. During the 1960s, many conglomerates were created by a firm enjoying a high price/earnings ratio (P/E). They then used their highly valued stock to acquire other firms that had lower P/E ratios, usually in unrelated domestic industries. These conglomerates went out of fashion during the 1980s when they lost their high P/E ratios, thus making it more difficult to find other firms with lower P/E ratios to acquire. During the 1990s, the same acquisition strategy was possible for firms located in countries where high P/E ratios were common compared to firms in other countries where low P/E ratios were common. Consider the hypothetical firms in the pharmaceutical industry shown in the table at the top of the next page. Modern American wants to acquire ModoUnico. It offers 5,500,000 shares of Modern American, with a current market value of $220,000,000 and a 10% premium on ModoUnico's shares, for all of ModoUnico's shares.
Problem:
Company P/E ratio Number of shares Market value per share Earnings EPS Total market value
ModoUnico 20 10,000,000 $20.00 $10,000,000 $1.00 $200,000,000
Modern America 40 10,000,000 $40.00 $10,000,000 $1.00 $400,000,000