Question：ST Inc makes a bid to acquire all the share capital of WV Inc, paying for the acquisition by means of a share exchange. The shares of ST Inc are currently trading on a P/E of 12.5 and the shares of WV Inc are trading on a P/E ratio of 15. No savings or increase in combined sales are expected as a result of the takeover.
Given no change in the annual profits after tax of either company, what will happen to the earnings per share of the combined ST group after the takeover?
A. EPS will remain the same.
B. EPS will go down.
C. It is impossible to assess, without figures for earnings and numbers of shares.
D. EPS will go up.
The correct answer is: EPS will go down.
When the bid consideration is all in shares and one company buys another on a higher P/E ratio, the EPS will fall after the takeover unless total profits can be increased after the takeover, perhaps through economies of scale or higher combined total sales. In this question, there are no such profit increases.
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