Copper Clapper Company currently has annual earnings of $10 million with 4 million shares of common stock outstanding and a market price per share of $30. In the absence of any mergers, Copper Clapper’s annual earnings are expected to grow at a compound rate of 5 percent per annum. Brass Bell Company, which Copper Clapper is seeking to acquire, has present annual earnings of $2 million, 1 million shares of common stock outstanding, and a market price per share of $36. Its annual earnings are expected to grow at a compound annual rate of 10 percent per annum. Copper Clapper will offer 1.2 shares of its stock for each share of Brass Bell Company.
a. What is the immediate effect on the surviving company’s earnings per share?
b. Would you want to acquire Brass Bell Company? If it is not attractive now, when will it be attractive from the standpoint of earnings per share?
The Correct Answer and Explanation is:
a. Immediate Effect on the Surviving Company’s Earnings Per Share (EPS)
Step 1: Calculate current EPS for both companies
- Copper Clapper (CC):
- Earnings = $10 million
- Shares = 4 million
- EPS = $10M / 4M = $2.50
- Brass Bell (BB):
- Earnings = $2 million
- Shares = 1 million
- EPS = $2M / 1M = $2.00
Step 2: Determine number of new shares issued in the merger
- Offer = 1.2 CC shares for each BB share
- Shares to be issued = 1M BB shares × 1.2 = 1.2 million new CC shares
Step 3: Total post-merger earnings and shares
- Combined earnings = $10M + $2M = $12 million
- Combined shares = 4M (existing CC) + 1.2M (new) = 5.2 million shares
Post-merger EPS = $12M / 5.2M = $2.31
✅ Answer: The immediate EPS of the surviving company is $2.31
Explanation (300 words):
The immediate effect of an acquisition on earnings per share (EPS) is an essential measure to assess whether the deal is accretive (EPS increases) or dilutive (EPS decreases). In this case, Copper Clapper Company is offering 1.2 of its own shares for each share of Brass Bell Company, effectively diluting its share base to absorb Brass Bell’s earnings.
Before the acquisition, Copper Clapper had an EPS of $2.50. Brass Bell had a lower EPS of $2.00, which suggests it is a lower-earning company on a per-share basis. The key here is to see if adding Brass Bell’s $2 million in earnings justifies the 1.2 million shares Copper Clapper must issue.
After the merger, Copper Clapper’s total earnings increase to $12 million, but the share count also rises to 5.2 million. This leads to a new EPS of $2.31, which is lower than the original $2.50. Since the EPS has declined post-merger, the deal is dilutive in the short term.
This drop occurs because the earnings being acquired ($2M) don’t sufficiently offset the dilution caused by issuing 1.2M new shares. This result is crucial to investors because a declining EPS often translates to a lower stock price, all else equal.
Therefore, while the merger may have strategic or long-term value, the immediate financial metric of EPS is negatively impacted.
b. Is the acquisition attractive now? When will it become attractive?
No, the acquisition is not attractive now because it is immediately EPS dilutive ($2.31 < $2.50). From a shareholder’s standpoint, this would signal reduced earnings per share and potentially lower share value in the short term.
To determine when the acquisition becomes attractive:
We compare the EPS growth of both companies.
- Copper Clapper EPS grows at 5%
- Brass Bell EPS grows at 10%
Since Brass Bell grows faster, its contribution to earnings will increase disproportionately over time. Eventually, the combined EPS will exceed the pre-merger EPS of Copper Clapper alone.
Let’s calculate when EPS becomes accretive:
Let tt be the number of years after which the combined EPS exceeds $2.50: CC earnings at time t=10(1.05)t\text{CC earnings at time } t = 10(1.05)^t BB earnings at time t=2(1.10)t\text{BB earnings at time } t = 2(1.10)^t Total earnings=10(1.05)t+2(1.10)t\text{Total earnings} = 10(1.05)^t + 2(1.10)^t EPS=10(1.05)t+2(1.10)t5.2\text{EPS} = \frac{10(1.05)^t + 2(1.10)^t}{5.2}
Set this equal to 2.50 and solve numerically:
Try t=4t = 4:
- CC earnings = 10 × 1.2155 = 12.155
- BB earnings = 2 × 1.4641 = 2.928
- Total = 15.083
- EPS = 15.083 / 5.2 = $2.90 > $2.50 ✅
So, the acquisition becomes EPS accretive after approximately 4 years.
✅ Conclusion:
The acquisition is dilutive now, but it becomes attractive after around 4 years, when Brass Bell’s faster earnings growth improves the combined EPS beyond Copper Clapper’s standalone EPS.
