Reference no: EM131690516

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