Problem:
Castor Corp. and Pollux Corp. each have 100 million shares and earnings per share of $2. Castor has a P/E ratio of 20, while Pollux has a P/E ratio of 15. Castor makes an offer to acquire Pollux, offering .80 shares of Castor for each share of Pollux; the offer is accepted by Pollux shareholders. Suppose that the combined firm (to be renamed Gemini), can generate increased annual earnings (synergy) of $30 million (with present value of $300 million). All numbers are after-tax. After the acquisition:
Q1. What is the share price of Gemini [the combined firm]?
Q2. What is the EPS of Gemini [the combined firm]?
Q3. What is the P/E ratio of Gemini [the combined firm]?
[Hint: What are the total value, total earnings and shares outstanding for Castor and for Pollux as separate firms? What are the total value, total earnings and shares outstanding for the combined firm Gemini, including the effect of the cost reduction?]
Q4. Are Pollux' shareholders made better off by the Castor offer?
Q5. Are Castor's shareholders made better off by the Castor offer?