Investment Banking · Topic lesson

Accretion / Dilution

Does a deal raise or lower the acquirer's EPS? Pro forma EPS, the P/E shortcut, synergies, purchase accounting and contribution analysis.

5 chapters About 59 minutes0 of 5 complete

Start chapter 1

When a public company buys another, the first question from its board and its shareholders is usually: what does this do to our earnings per share? If EPS goes up, the deal is accretive; if it goes down, dilutive. Merger models are built around that question, and interviews test it from every direction.

What you pay is the offer price: the target's unaffected share price plus a premium, typically 20–40% for control. It is paid in cash, stock, new debt, or a mix.
What each currency costs is a yield: interest lost on cash, interest on debt, and the earnings that go with every new share.
What you get is the target's earnings, plus synergies, less the costs of achieving them and the extra amortization from purchase accounting.

The rule that solves every question

A deal is accretive when the earnings it buys outrun what it costs to pay for them. And accretion is an accounting test, not proof of value: a deal can raise EPS and still overpay.

How to judge a deal's effect on EPS

The order to work in. Each step points to the chapters that practice it.

1
Price the deal
Offer price = unaffected price × (1 + premium); purchase P/E follows.
Chapter 1 Chapter 2
2
Choose how to pay
Cash, stock or debt, each with its own cost as a yield.
Chapter 2 Chapter 1
3
Add what the deal brings
The target's earnings, plus synergies phased in and net of the costs to achieve them.
Chapter 1 Chapter 3
4
Take off the hidden costs
Amortization of the asset step-up from purchase accounting.
Chapter 4
5
Check who gets what
Pro forma EPS against standalone; in a stock deal, ownership against contribution.
Chapter 1 Chapter 5

Chapters

Pro forma EPS: accretive or dilutive?

14 min

Does buying the company raise or lower the acquirer's earnings per share? Build the answer line by line.

Build pro forma net income and the pro forma share count for a mixed cash, stock and debt deal
Calculate pro forma EPS and the accretion or dilution
Work out the synergies needed to break even
Explain why accretion is not the same as creating value

The P/E shortcut: cash versus stock

12 min

Tell whether a deal is accretive in your head, by comparing the yield you buy with the yield you pay.

Turn a P/E and an interest rate into yields you can compare
Say whether an all-stock or all-debt deal is accretive without building the model
Work out the highest premium before a deal turns dilutive
Explain which currency is cheaper, and why high-P/E companies pay in stock

Synergies: phasing and costs to achieve

11 min

The announced synergy number is a run-rate. Year one gets a fraction of it, less the cost of getting there.

Phase run-rate synergies and subtract the costs to achieve them, year by year
Explain why year one can show a net cost
Work back from year-one net synergies to the run-rate management is implying
Value the run-rate and compare it with the one-off cost

Purchase accounting: goodwill and the step-up

12 min

Where the purchase price goes on the balance sheet, and the extra amortization it creates.

Calculate goodwill with and without an asset write-up
Explain the deferred tax liability a stock deal creates
Work back from reported goodwill to the write-up
Calculate the yearly net income hit from amortizing the step-up

Contribution analysis

10 min

In a stock deal, does each side's share of the combined company match what it brings to the table?

Calculate each side's contribution to combined revenue, EBITDA and net income
Calculate the target's pro forma ownership in a stock deal
Work out the offer that would match ownership to contribution
Explain why the metrics give different answers