Two companies called Blur plc and Oasis plc are considering a merger. Financial data for the two companies are given below:
Blur Oasis
Number of shares issued............. 3m..................6m
Profit after tax ..........................£1.8m........... £0.5m
Price/earnings ratio.................... 12.0............... 10.3
The two companies have estimated that, due to economies of scale, the newly merged company would generate cost savings of £200,000 per year.
(a) It is suggested initially that 100 per cent of Oasis's shares should be exchanged for shares in Blur at a rate of one share in Blur for every three shares in Oasis. What would be the expected reduction of EPS from the point of view of Blur's shareholders?
(b) An alternative to this is for Blur's shares to be valued at £7.20 and for the total share capital of Oasis to be valued at £10.5m for merger purposes. A certain percentage of Oasis's shares would be exchanged for shares in Blur, while the remaining shares of Oasis would be exchanged for 6.5 per cent bonds (issued at £100 nominal value) in the new company. Given that the corporate tax rate is 30 per cent, how much would have to be raised from the bond issue as part of the purchase consideration in order for there to be no dilution of EPS from Blur's existing shareholders' point of view?