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What is the price-to-earnings ratio of the combined firm

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Question - Elbur considers acquiring Spoof Inc., a company with 1,000 shares outstanding trading at $40 per share and $25,000 worth of risk free perpetual debt. Spoof Inc. does not make any investments and thus does not grow. Elbur contemplates the following deal. It will buy Spoof Inc. for $75,000 (you have to buy out both equity and debt) all financed by a perpetual risk free debt. The tax rate of the combined firm will be 35%.

(i) Unfortunately, Elbur's CFO does not know Spoof's tax rate. However, while reading Spoof's 10-K, she finds out that when Spoof increased its debt by $5,000 (perpetual and risk free) its stock price increased by $1.50. Use this info to find Spoof's tax rate, τS.

(ii) Calculate the share price of the combined firm;

(iii) What is the price-to-earnings ratio of the combined firm if Spoof's price-toearnings ratio is equal to 10?

Reference no: EM132971191

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