P/E Ratio

Assumptions:
Acquiring firm is larger than target firm
Larger firm has PE Ratio of 25:1
Annual earnings are Rs. 1,000,000
1,000,000 shares are outstanding
Target firm has PE Ratio of 10:1
Annual earnings are Rs. 100,000
100,000 shares are outstanding

Offer from large firm stock-for-stock,

one share of acquirer for two shares of
target
Large firm issues 50000 shares to
finance the purchase

 Acquisition causes EPS of higher P/E firm to

rise
1 share was earning Rs. 1. Now 1 share is
earning Rs.1.05 ( 1100000/1050000)
Assuming that PE ratio of combined firm
remains same. Stock price will rise to Rs. 26.25
( 25*1.05)
This way large firm can continue to offer small
firm significant premium while its EPS and
stock price rises