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Chapter 5: 11BP (page 653)

Assume the Knight Corporation is considering the acquisition of Day Inc. The expected earnings per share for the Knight Corporation will be \(4.00 with or without the merger. However, the standard deviation of the earnings will go from \)2.40 to $1.60 with the merger because the two firms are negatively correlated.

a.Compute the coefficient of variation for the Knight Corporation before and after the merger (consult Chapter 13 to review statistical concepts if necessary).

b.Discuss the possible impact on Knight’s postmerger P/E ratio, assuming investors are risk-averse.

Short Answer

Expert verified

Coefficient of variance before and after merger are $0.60 and $0.40 respectively. The post-merger coefficient of variation of the company is $0.40.

Step by step solution

01

Definition of coefficient of variation

The coefficient variation means the ratio of standard deviation to the earnings per share.

02

Calculation of the coefficient of variation

Coefficient of variation before the merger

CoefficientofVariation=StandardDeviationEarningsPerShare=$2.40$4.00=0.60

Post-merger coefficient of variation,

CoefficientofVariation=StandardDeviationEarningsPerShare=$1.60$4.00=0.40

03

Effect on the P/E ratio

The P/E ratio of Knight is increase because the risk-averse investors reduces the risk.

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