Lecture 4

Question 1

What is EPS Bootstrapping?

Answer 1

• Is a way of packaging the combined earnings from two companies after a merger so that the merger generates an increase in the earnings per share (EPS) of the acquirer

Question 2

When does bootstrapping effect occur?

Answer 2

The bootstrap effect occurs when a high growth prospects firm (high P/E) acquires a low growth prospects firm (low P/E) in a stock transaction.

Post merger, the earnings of the combined firms are simply the sum of the respective earnings prior to the merger. However, by purchasing the firm with lower P/E, the acquiring firm is essentially exchanging higher priced shares for lower priced shares. As a result, the number of shares outstanding for the acquiring firm increases, but at a ratio that is less than 1-for-1

Question 3

Name three different valuation measures

Answer 3

DCF, comparable company analysis, precedent transaction

Question 4

Is the bootstrap effect long term?

Answer 4

No
While the bootstrap effect may provide a temporary increase in the stock price if investors don´t realize the trickery, the effect will tend to disappear over time (eventually the P/E will adjust and the stock price will go down)