private equity firms are known to buy medium sized private companies o
Private equity firms are known to buy medium sized private companies operating in the same industry, merge them together into a larger company, and then sell it off in a public float (initial public offering, IPO).If medium-sized private companies trade at PE ratios of 4 and larger listed companies trade at PE ratios of 20, what return can be achieved from this strategy?Assume that:• The medium-sized companies can be bought, merged and sold in an IPO instantaneously.• There are no costs of finding, valuing, merging and restructuring the medium sized companies. Also, there is no competition to buy the medium-sized companies from other private equity firms.• The large merged firm's earnings are the sum of the medium firms' earnings.• The only reason for the difference in medium and large firm's PE ratios is due to the illiquidity of the medium firms' shares.Return is defined as: r = P1/ PO - 1 where time zero is just before the merger and time one is just after. а. 500%. b. 400% с. 300% d. 25% е. 20%
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