 The side effects of an acquisition deal can be considered in terms of earnings growth and diversification So far as earning growth is concerned an acquisition may fool investors on affirms EPS growth more than what it really is Let's take an example of two firms to understand this earning magic One firm we have is the global resources. Whereas the other firm is the regional enterprises if we see on the screen both the firms have an EPS of $1 whereas the price per share for global is 25 dollars and regional is 10 dollars per share Number of shares of our both of the companies are 100 as to the outstanding shares Whereas the total earnings of global is 100 dollars and same is true for the regional enterprises the total value of global is therefore comes to $2,500 dollars whereas it is $1,000 for regional enterprises using this data if we see the price earning ratio of a Global resources it is 25 times whereas it is 10 times for regional enterprises Now the question arises that do the investors are getting a better deal with regional enterprises? the answer is that not necessarily because Global's earning are expected to grow faster than the regional's earnings and This is the fact that market Expectation of growth rate in earnings of a firm determines its are a price earning ratio Now assume that in this acquisition there is a zero synergy effect between the two firms Then if the market thinks smartly, then what will happen? We know that in this particular situation the combined value of the firm after acquisition is equal to the individual sum of individual values of global and the individual value of the resources enterprises and That sum is equal to 3,500 US dollars at this if the global acquires regional at a ratio of 4,200 shares then the situation appears if we see on the screen that the earnings per share will be 1.43 dollars for the global and Price per share is same at 25 US dollars number of shares will go from 100 to 140 outstanding by the global the total earnings will go up global become Equal to $200 whereas the total value will be equal to $3,500 and at this level of data the price earning ratio will be 17.5 Times for the global Now the question again arises that why the global earning a price earning ratio has dropped from $25 to 25 times to 17.5 times The answer is that the EPS of the combined firms is equal to the average of the EPS of the global firm which is a high growth firm and the EPS of the original firm which is which is basically the low growth firm So we can draw a conclusion that the global price earning ratio should drop taking our new division That has a low growth rate in its earnings What will happen if the market is pulled then? The market might take the global's 43% earning Increase in its EPS for a true growth and that 43% is from EPS of $1 to $1.43 per share at in this case There will be no fall in the global's price earning ratio as if we see the after Acquisition situation the earnings per share is $1.43 a price per share is now $5.71 for the global number of shares are 140 these are the outstanding shares total earnings after acquisition are $200 and the total value is now equal to $5,000 and at this data the price earning ratio of global after acquisition is same at 25 times so we see that at the price earning ratio of 25 times the value of combined firm is now equal to $5,000 and the global's new stock price is now $35.71 and this is how earnings magic can work This appears that the market is too smart to be fooled by this this magic very much easily The second effect that can be seen as an outcome of an acquisition deal is the diversification Diversification is regarded as a benefit for the acquirer But there is an argument against the diversification that it does not increase in any value However merger are meant Sometimes for diversifying thus unsystematic risk, but investors individually does not need companies that are widely diversified for this particular risk elimination Because individually investors can do more easily this work by purchasing common shares in different companies So diversification through conglomerate Mergers may not benefit the shareholders But diversification can benefit the acquirer subject to certain conditions like If diversification reduces unsystematic risk at a lower cost then the individual's judgment on his personal portfolio The second if the diversification reduces the risk and increases the post acquisition debt capacity