The Nebraska Corporation is considering acquiring the Lincoln Corporation. The data for the two companies are as follows:
Lincoln Corp. Nebraska Corp.
Total earning............................... $500,000 $2,000,000
Number of Shares of stock outstanding.........200,000 1,000,000
Earnings per share.................................. $2.50 $2.00
Price-earnings ratio (P/E)...........................16 20
Market price per share............................ $40 $40
a. The Nebraska Corp. is going to give Lincoln Corp. a 50 percent premium over Lincoln Corp.'s current market value. What price will it pay?
b. At the price computed in part a. what is the total market value of Lincoln Corp.? (Use number of Lincoln Corp. shares time price.)
c. At the price computed in part a, what is the P/E ratio Nebraska Corp. is assigning to Lincoln Corp.?
d. How many shares must Nebraska Corp. issue to buy the Lincoln Corp. at the total value computed in part b? (Keep in mind Nebraska Corp.'s price per share is $40.)
e. Given the answer to part d, how many shares will Nebraska Corp. have after the merger?
f. Add together the total earnings of both corporations and divide by the total shares computed in part e. What are the new postmerger earnings per share?
g. Why have Nebraska Corp.'s earnings per share gone down?
h. How can Nebraska Corp. hope to overcome this dilution?