Question 11.Qfr.3: Carsley plc and Powell plc are planning to merge to form Sti...
Carsley plc and Powell plc are planning to merge to form Stimac plc. It has been agreed that Powell’s shareholders will accept three shares in Carsley for every share in Powell they hold. Other details are as follows:
| Carsley plc | Powell plc | |
| Number of shares | 40m | 10m |
| Annual earnings | £10m | £5.8m |
| Price/earnings ratio | 8 | 10 |
Post-merger annual earnings of the enlarged company are expected to be 8 per cent higher than the sum of the earnings of each of the companies before the merger, due to economies of scale and other benefits. The market is expected to apply a P/E ratio of 9 to Stimac plc.
Determine the extent to which the shareholders of Powell will benefit from the proposed merger.
Powell’s market value, using its P/E ratio and earnings, is 5.8m × 10 = £58m
The earnings of Stimac plc will be (£10m + £5.8m) × 1.08 = £17.06m
Using the expected P/E ratio of 9, the value of Stimac is £17.06m × 9 = £153.54m
The 10 million shares of Powell will be swapped for 30 million Carsley shares, making 70 million shares in the new company in total. Therefore, the wealth of Powell’s shareholders will now be £153.54m × (30m/70m) = £65.8m.
Powell’s shareholders are £7.8m better off (78 pence per share).