# Accretion and Dilution Concept Card: [Deal, course or case] > A concept card for the M&A elective: how an acquisition changes the buyer's earnings per share (EPS) once the full > merger model is built, with the payment mix, cash on hand, new debt, purchase price allocation amortisation, deal > costs, synergy phase-in and costs to achieve, and how to read the result next to leverage, ownership and value. It > builds on the quick test in section 5 of mba/mba-banking-technical-prep (compare the cost of each acquisition > currency with the target's earnings yield) and on mba/mba-capital-structure-card; read those first, because this card > does not re-teach them. Source basis: IAS 33 *Earnings per Share* (and ASC 260 under US GAAP) for the definition of > EPS, IFRS 3 *Business Combinations* for the acquisition method, and the research on payment form and signalling > (Myers and Majluf 1984; Travlos 1987; Rappaport and Sirower 1999), written up in original words. The examples use > fictional companies with generic labels (Acquirer P and Target Q, the same deal as mba/mba-synergy-valuation-card). > Replace every [bracketed] value and every row marked *Example*. This is a learning aid, not investment or accounting > advice. ## Document control | Field | Value | |---|---| | Deal, course or case | [Deal name or case] | | Learner or analyst | [Your name] | | Acquirer and target | [Acquirer P / Target Q (fictional) or your case] | | Assumption set | [Base, management, downside] | | Accounting basis | [IFRS / US GAAP] | | Reviewed by | [Learning team member, tutor or mentor] | | Version | [0.1] | | Last updated | YYYY-MM-DD | ## Contents 1. When to use it 2. The idea in plain language 3. Formulas and notation 4. Assumptions and limits 5. How managers use it in practice 6. Worked example A (fully solved): Acquirer P and Target Q 7. Worked example B (half solved): Acquirer R and Target S 8. Exercise C (unsolved) 9. Connections to other cards 10. Common mistakes and misconceptions 11. Self-test questions 12. My notes and next steps 13. Sources and further reading 14. Answer key 15. Revision history ## When to use it | Use it when | Use something else when | |---|---| | A listed acquirer must show investors how a deal changes EPS in the first two or three years | You need to decide whether the deal creates value (mba/mba-synergy-valuation-card, mba/mba-dcf-valuation-card) | | You compare cash, stock and mixed consideration | The buyer is a financial sponsor; use returns, not EPS (mba/mba-lbo-model-card) | | You need the synergies required to avoid dilution, or the highest EPS-neutral price | The target is a private start-up bought for technology; EPS effects are noise next to strategy | | You prepare for a banking or corporate development interview | You need detailed structuring of earn-outs or collars (mba/mba-deal-structuring-card) | ## The idea in plain language When a company buys another, it adds the target's earnings to its own, but it pays with something that also has an earnings cost. Paying in **new shares** spreads the combined earnings over more shares; the cost of each share is the acquirer's earnings yield (the inverse of its P/E). Paying in **new debt** adds interest, reduced by the tax shield. Paying with **cash on hand** gives up the interest that cash was earning, also after tax. The deal is accretive when the earnings bought (the target's earnings yield at the offer price) exceed the weighted earnings cost of the currencies used. The quick test in mba/mba-banking-technical-prep does exactly this. A full merger model adds four layers the quick test ignores: 1. **Purchase price allocation.** Under the acquisition method (IFRS 3; ASC 805), the target's identifiable assets are remeasured at fair value. Acquired intangible assets with finite lives (customer relationships, technology, brands with a finite life) are amortised, which lowers reported earnings every year. Goodwill is not amortised under IFRS (it is tested for impairment under IAS 36) nor, for public companies, under US GAAP (ASC 350); US private companies may elect a goodwill amortisation alternative (check the FASB Codification). Many acquirers also report an adjusted or "cash" EPS that adds back acquired amortisation, so state which EPS you show. 2. **Deal costs and financing fees.** Advisory, legal and valuation costs are expensed when incurred (IFRS 3 paragraph 53; ASC 805) and are usually excluded from forward EPS; they still have to be paid, from cash or debt. The exception is the cost of issuing securities: debt issue costs reduce the carrying amount of the debt and are spread over its life through the effective interest rate (IFRS 9), and equity issue costs are deducted from equity (IAS 32). This card treats the USD 25m of deal costs in example A as advisory costs. 3. **Synergies and costs to achieve.** Cost synergies phase in over one to three years; revenue synergies are often excluded from the EPS case because analysts discount them; one-off costs to achieve depress reported earnings in the first years. 4. **Timing and share count.** EPS under IAS 33 uses the weighted average number of ordinary shares during the period, so shares issued at a mid-year closing count only for the months they are outstanding. The deeper lesson is that EPS is an accounting ratio, not a measure of value. A cash deal funded with cheap debt is almost always accretive, even if the buyer overpays, because the after-tax interest rate is lower than most earnings yields. A stock deal by a low-P/E buyer is dilutive even if it creates value. Boards still care about accretion because markets, rating agencies and compensation plans watch EPS, so the right use of this card is as a **constraint and communication tool** alongside value, leverage and risk sharing. ## Formulas and notation **Pro forma EPS** (deal closes at the start of the year; amounts for year $y$): $$ EPS_{PF,y} = \frac{NI_{A,y} + NI_{T,y} + \left(S_y - C_y - Am - r_D D - r_C K\right)(1 - t)}{N_A + N_{new}} $$ **New shares, cash and debt** for a share $\alpha$ of the price $P$ paid in stock and deal costs $F$: $$ N_{new} = \frac{\alpha P}{P_A}, \qquad K = \min\left(K_0, (1-\alpha) P + F\right), \qquad D = (1-\alpha) P + F - K $$ **Accretion or dilution:** $$ \text{Accretion}_y = \frac{EPS_{PF,y}}{EPS_{A,y}} - 1, \qquad EPS_{A,y} = \frac{NI_{A,y}}{N_A} $$ **Quick test** (no synergies, amortisation or fees; all stock or all debt): $$ \text{All stock accretive} \iff \frac{P_A}{EPS_A} > \frac{P}{NI_T}, \qquad \text{All debt accretive} \iff r_D (1-t) < \frac{NI_T}{P} $$ **Break-even pre-tax synergies** (synergies that make the deal EPS-neutral in year $y$), where $NI_{PF,y}^{0}$ is pro forma net income without synergies: $$ S_y^{*} = \frac{EPS_{A,y} (N_A + N_{new}) - NI_{PF,y}^{0}}{1 - t} $$ **Ownership, contribution and leverage:** $$ \omega_T = \frac{N_{new}}{N_A + N_{new}}, \qquad c_T = \frac{NI_T}{NI_A + NI_T}, \qquad L = \frac{ND_A + ND_T + D + K}{EBITDA_A + EBITDA_T + S} $$ Cash on hand used ($K$) raises net debt just as new debt ($D$) does, because net debt is debt minus cash. | Symbol | Meaning | Unit | |---|---|---| | $NI_{A,y}$, $NI_{T,y}$ | Standalone net income of acquirer and target in year $y$ | USD m | | $S_y$ | Pre-tax synergies included in the EPS case in year $y$ (net of dis-synergies) | USD m | | $C_y$ | Pre-tax one-off costs to achieve synergies (zero in an adjusted EPS case) | USD m | | $Am$ | Pre-tax amortisation of acquired intangible assets | USD m per year | | $r_D$, $r_C$ | Pre-tax interest rate on new debt; pre-tax interest forgone on cash on hand | % | | $D$, $K$, $K_0$ | New debt; cash on hand used; cash on hand available | USD m | | $P$, $F$ | Equity purchase price; deal costs | USD m | | $\alpha$ | Share of the price paid in acquirer stock | 0 to 1 | | $P_A$ | Acquirer share price at which new shares are issued | USD | | $N_A$, $N_{new}$ | Acquirer shares before the deal; new shares issued | m | | $t$ | Tax rate | % | | $\omega_T$, $c_T$ | Target holders' ownership of the combined firm; target's contribution to combined net income | % | | $L$ | Pro forma net debt to EBITDA | x | ## Assumptions and limits - **EPS ignores the cost of risk.** Debt-funded accretion comes with higher leverage, a higher cost of equity and possible rating pressure (mba/mba-capital-structure-card). Two deals with the same accretion can differ greatly in value. - **EPS ignores the premium relative to synergies.** A deal can be accretive and still transfer more value to the target's shareholders than the synergies create. - **The issue price is not fixed.** New shares are modelled at the current price, but announcement reactions (often negative for stock-financed bids, Travlos 1987) and fixed or floating exchange ratios change the real cost. - **Analysts' EPS is a choice.** Adjusted EPS excludes costs to achieve and sometimes amortisation; reported EPS under IAS 33 includes them. Always show both. - **Standalone forecasts are contestable.** Accretion depends on both firms' forecasts; a target with an optimistic plan makes any deal look accretive. - **The model is static.** Debt paydown, share buy-backs, refinancing of the target's debt and changes in tax rates move the numbers in years 2 and 3. This card holds debt constant to keep the mechanics visible. - **Purchase price allocation is an estimate.** Fair values and useful lives are set after closing with valuation specialists; early models use ranges. ## How managers use it in practice 1. **Value first.** Decide the walk-away price from standalone value and net synergies (mba/mba-synergy-valuation-card). 2. **Build the standalone forecasts** of both companies on consistent accounting and calendar years. 3. **Lay out sources and uses**: price, refinancing of target debt, fees, against cash on hand, new debt and new stock. 4. **Estimate purchase price allocation**: intangible step-ups, lives, deferred tax, goodwill. 5. **Run EPS for each payment mix** for years 1 to 3, adjusted and reported, with and without synergies. 6. **Check the constraints**: leverage against covenants and rating thresholds, ownership and voting, the need for a shareholder vote when many shares are issued (check the listing rules that apply). 7. **Find break-evens**: synergies for EPS neutrality, highest EPS-neutral price, payment mix at which accretion turns negative. 8. **Communicate**: lead with value and strategy, then accretion timing and the synergy plan. ```mermaid flowchart TD A["Walk-away price from value and net synergies"] --> B["Standalone forecasts of both firms"] B --> C["Sources and uses: cash, debt, stock, fees"] C --> D["Purchase price allocation: step-ups, amortisation, goodwill"] D --> E["Pro forma EPS by payment mix, years 1 to 3"] E --> F{"Leverage within covenants and rating target?"} F -- No --> G["Raise the stock share or lower the price"] G --> E F -- Yes --> H{"Dilution acceptable and explainable?"} H -- No --> I["Check break-even synergies and EPS-neutral price"] I --> J{"Still below the walk-away price?"} J -- Yes --> K["Adjust mix or price within value limits"] K --> E J -- No --> L["Walk away or renegotiate"] H -- Yes --> M["Board pack: value first, then EPS, leverage, ownership"] ``` ## Worked example A (fully solved): Acquirer P and Target Q **Situation (*Example*, fictional).** Acquirer P, a listed company, agrees to buy Target Q, a listed competitor with no debt, at a 30% premium. The synergy case comes from mba/mba-synergy-valuation-card (same deal): cost synergies of USD 30m in year 1 and USD 60m in year 2, net of dis-synergies of USD 6m and USD 12m. Revenue synergies are excluded from the EPS case, as analysts usually do. Costs to achieve are USD 70m in year 1 and USD 30m in year 2. The deal closes at the start of year 1. | *Example* input | Acquirer P | Target Q | |---|---|---| | Net income, year 1 / year 2 (USD m) | 400.0 / 420.0 | 90.0 / 94.5 | | Shares (m) | 250.0 | 60.0 | | Share price (USD) | 28.00 | 22.50 | | EBITDA (USD m) | 700.0 | 150.0 | | Net debt (USD m) | 900.0 | 0.0 | | Cash on hand available for the deal (USD m) | 200.0, earning 3.0% pre-tax | | Other inputs: tax rate 25%; new debt at 6.0% pre-tax; deal costs USD 25m paid from cash on hand first; acquired intangible assets of USD 300m amortised over 10 years (USD 30m a year); new shares issued at USD 28.00. **Step 1. Price and quick test.** | Item | Computation | Result | Excel formula | |---|---|---|---| | Acquirer EPS, year 1 | 400 / 250 | 1.6000 | `=400/250` | | Acquirer P/E | 28.00 / 1.60 | 17.50x | `=28/(400/250)` | | Offer per share | 22.50 x 1.30 | 29.25 | `=22.5*(1+30%)` | | Equity purchase price | 29.25 x 60 | 1,755.0 | `=29.25*60` | | P/E paid (year 1) | 1,755 / 90 | 19.50x | `=1755/90` | | Target earnings yield at offer | 90 / 1,755 | 5.13% | `=90/1755` | | Cost of stock (acquirer earnings yield) | 1 / 17.5 | 5.71% | `=1/17.5` | | After-tax cost of new debt | 6.0% x 0.75 | 4.50% | `=6%*(1-25%)` | | After-tax cost of cash on hand | 3.0% x 0.75 | 2.25% | `=3%*(1-25%)` | Quick test: stock costs 5.71% but buys 5.13%, so an all-stock deal is dilutive before synergies; debt and cash cost less than 5.13%, so an all-cash deal is accretive before amortisation and synergies. Without amortisation and synergies, the full model gives all cash EPS 1.6576 (+3.60%) and all stock 1.5653 (-2.17%). **Step 2. Sources and uses for three payment mixes.** | *Example* mix | New shares (m) | Cash on hand used | New debt | Pre-tax financing cost | After-tax financing cost | |---|---|---|---|---|---| | All cash ($\alpha$ = 0) | 0.0000 | 200.0 | 1,580.0 | 6.00 + 94.80 = 100.80 | 75.60 | | Half and half ($\alpha$ = 0.5) | 31.3393 | 200.0 | 702.5 | 6.00 + 42.15 = 48.15 | 36.11 | | All stock ($\alpha$ = 1) | 62.6786 | 25.0 | 0.0 | 0.75 | 0.56 | Excel: new shares `=alpha*1755/28`; cash used `=MIN(200,(1-alpha)*1755+25)`; new debt `=(1-alpha)*1755+25-cash_used`; financing cost `=cash_used*3%+debt*6%`. **Step 3. Pro forma net income and EPS, all cash, year 1 (adjusted: costs to achieve excluded).** | Line | USD m | Excel formula | |---|---|---| | Acquirer net income | 400.00 | input | | Target net income | 90.00 | input | | After-tax financing cost | -75.60 | `=-100.8*(1-25%)` | | After-tax amortisation | -22.50 | `=-30*(1-25%)` | | After-tax synergies (24 pre-tax) | 18.00 | `=24*(1-25%)` | | Pro forma net income | 409.90 | `=SUM(above)` | | Pro forma EPS | 1.6396 | `=409.9/250` | | Accretion | +2.47% | `=1.6396/1.6-1` | **Step 4. All mixes and years (adjusted EPS, amortisation included).** | *Example* mix and year | EPS without synergies | Accretion | EPS with synergies | Accretion | |---|---|---|---|---| | All cash, year 1 | 1.5676 | -2.03% | 1.6396 | +2.47% | | All cash, year 2 | 1.6656 | -0.86% | 1.8096 | +7.71% | | Half and half, year 1 | 1.5333 | -4.17% | 1.5973 | -0.17% | | Half and half, year 2 | 1.6204 | -3.55% | 1.7484 | +4.07% | | All stock, year 1 | 1.4933 | -6.67% | 1.5509 | -3.07% | | All stock, year 2 | 1.5717 | -6.45% | 1.6868 | +0.41% | Standalone EPS is 1.60 in year 1 and 1.68 in year 2. With costs to achieve included (closer to reported EPS), year 1 falls to 1.4296 (-10.65%) all cash and 1.3830 (-13.56%) all stock, and the USD 25m of advisory deal costs expensed at closing would lower reported year 1 further: the first reported year after a deal is usually dilutive. **Step 5. Break-evens.** | Item | Result | How | |---|---|---| | Year 1 pre-tax synergies for EPS neutrality, all stock | 44.46 | $S^{*}$ formula; Excel `=(1.6*312.6786-466.9375)/(1-25%)` | | Year 1 pre-tax synergies for EPS neutrality, half and half | 25.01 | Same, with 281.3393 shares and 431.3875 income; plan is 24, so slightly dilutive | | Share of stock at which year 1 accretion turns negative | 46.46% | Goal Seek on $\alpha$ for accretion = 0 | | Highest offer per share that keeps all stock EPS-neutral in year 2 | 29.84 (32.64% premium) | Goal Seek on the offer for year 2 accretion = 0, holding amortisation at USD 30m | **Step 6. Constraints.** | Item | All cash | All stock | Excel formula (all cash) | |---|---|---|---| | Pro forma net debt (USD m) | 2,680.0 | 925.0 | `=900+1755+25` | | Net debt / (EBITDA + year 1 synergies of 24) | 3.07x | 1.06x | `=2680/(700+150+24)` | | Target holders' ownership | 0.00% | 20.05% | `=62.6786/312.6786` | | Target contribution to combined net income | 18.37% | 18.37% | `=90/490` | | Exchange ratio (P shares per Q share) | n/a | 1.0446 | `=29.25/28` | The acquirer's standalone leverage is 1.29x (`=900/700`). All cash more than doubles it; whether 3.07x is acceptable depends on covenants and the rating target. In the stock deal, Q's holders get 20.05% of the shares while contributing 18.37% of the net income: a sign that P is paying a premium in shares. **Chart.** Accretion against the share of stock, adjusted EPS with synergies: ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Acquirer P and Target Q (fictional): EPS accretion against the share of the price paid in stock, years 1 and 2, adjusted EPS with cost synergies", "width": "container", "height": 260, "data": { "values": [ {"stock": 0, "year": "Year 1", "accretion": 2.47}, {"stock": 0, "year": "Year 2", "accretion": 7.71}, {"stock": 10, "year": "Year 1", "accretion": 1.89}, {"stock": 10, "year": "Year 2", "accretion": 6.91}, {"stock": 20, "year": "Year 1", "accretion": 1.34}, {"stock": 20, "year": "Year 2", "accretion": 6.15}, {"stock": 30, "year": "Year 1", "accretion": 0.82}, {"stock": 30, "year": "Year 2", "accretion": 5.43}, {"stock": 40, "year": "Year 1", "accretion": 0.31}, {"stock": 40, "year": "Year 2", "accretion": 4.73}, {"stock": 50, "year": "Year 1", "accretion": -0.17}, {"stock": 50, "year": "Year 2", "accretion": 4.07}, {"stock": 60, "year": "Year 1", "accretion": -0.63}, {"stock": 60, "year": "Year 2", "accretion": 3.44}, {"stock": 70, "year": "Year 1", "accretion": -1.07}, {"stock": 70, "year": "Year 2", "accretion": 2.83}, {"stock": 80, "year": "Year 1", "accretion": -1.49}, {"stock": 80, "year": "Year 2", "accretion": 2.25}, {"stock": 90, "year": "Year 1", "accretion": -1.89}, {"stock": 90, "year": "Year 2", "accretion": 1.69}, {"stock": 100, "year": "Year 1", "accretion": -3.07}, {"stock": 100, "year": "Year 2", "accretion": 0.41} ] }, "mark": {"type": "line", "point": true}, "encoding": { "x": {"field": "stock", "type": "quantitative", "title": "Share of price paid in stock (%)"}, "y": {"field": "accretion", "type": "quantitative", "title": "EPS accretion (%)"}, "color": {"field": "year", "type": "nominal", "title": "Year"} } } ``` Reading the chart: each 10 points of stock replace debt costing 4.50% after tax with shares costing 5.71%, so accretion falls steadily. The last step, from 90% to 100% stock, is steeper because it replaces cash on hand, the cheapest currency at 2.25% after tax. Year 2 sits higher because synergies reach their run-rate. **Conclusion (*Example*).** All cash maximises accretion (+2.47% and +7.71%) but takes leverage to 3.07x. All stock is dilutive in year 1 (-3.07%) and roughly neutral in year 2 (+0.41%). Half and half is near neutral in year 1 (-0.17%), accretive in year 2 (+4.07%) and keeps leverage moderate. The choice should follow from value and risk sharing: the synergy card shows the deal creates value only if most cost synergies arrive, which argues for sharing that risk with Q's holders through some stock. ## Worked example B (half solved): Acquirer R and Target S **Situation (*Example*, fictional).** Acquirer R (net income USD 150m, 100m shares, price USD 27.00) offers a 35% premium for Target S (net income USD 30m, 40m shares, price USD 9.00), all in R shares. Tax rate 25%. Ignore fees and synergies at first. | Item | Computation | Result | |---|---|---| | R EPS and P/E | 150 / 100; 27 / 1.50 | 1.50; 18.0x | | Offer per share and price | 9.00 x 1.35; x 40 | 12.15; 486.0 | | P/E paid | 486 / 30 | 16.2x | | Quick test: accretive or dilutive? | Compare 18.0x with 16.2x | [ ] | | New shares | 486 / 27 | [ ] | | Pro forma EPS and accretion | (150 + 30) / (100 + new shares) | [ ] | | With acquired intangibles amortised at USD 12m a year pre-tax | (150 + 30 - 12 x 0.75) / (100 + new shares) | [ ] | Question: does amortisation change the sign of the answer? What would you tell R's board? ## Exercise C (unsolved) Acquirer U (net income USD 900m, 300m shares, price USD 45.00, net debt USD 1,200m, EBITDA USD 1,500m) wants to buy Target V (net income USD 120m, 80m shares, price USD 20.00, no debt, EBITDA USD 220m) at a 40% premium. Consideration 60% cash (new debt at 5.5% pre-tax) and 40% U shares. Deal costs USD 30m from new debt. Intangible step-up USD 400m over 8 years. Run-rate cost synergies USD 50m pre-tax, 40% in year 1 and 100% from year 2; costs to achieve USD 60m in year 1. Tax 25%. Net income of both grows 5% a year. 1. Compute adjusted and reported EPS accretion for years 1 and 2. 2. Find the year 1 break-even synergies and the share of stock at which year 2 accretion is zero. 3. Compute pro forma leverage and V holders' ownership. 4. Write a three-sentence board message that starts with value, not EPS. ## Connections to other cards - mba/mba-banking-technical-prep (section 5): the quick test and interview answers this card extends. - mba/mba-synergy-valuation-card: the value of the same synergies, and whether the premium is justified. - mba/mba-mergers-acquisitions-guide: the full deal logic, including the Northfield mini-case with a payment-form table. - mba/mba-deal-structuring-card: fixed and floating exchange ratios, collars and earn-outs that change the share count. - mba/mba-capital-structure-card: why debt-funded accretion raises risk; signalling (Myers and Majluf 1984). - mba/mba-three-statements-card: how amortisation, deferred tax and goodwill flow through the statements. - mba/mba-lbo-model-card and mba/mba-paper-lbo: the financial buyer, who looks at returns instead of EPS. - finance/comparable-companies-analysis: P/E and EV/EBITDA inputs. ## Common mistakes and misconceptions 1. **"Accretive means good."** Accretion says nothing about the premium relative to synergies or the risk added. 2. **Pre-tax interest.** Interest must be taken after tax; using pre-tax interest makes every cash deal look worse. 3. **Forgetting the cost of cash on hand.** Cash used to pay was earning interest; that income disappears. 4. **Leaving out amortisation of acquired intangibles** in reported EPS, or including it without saying so in adjusted EPS. 5. **Full run-rate synergies in year 1.** Phase-in and costs to achieve make year 1 the weakest year. 6. **Wrong share count.** New shares must be computed at the acquirer's price, and only for the period outstanding (IAS 33 weighted average) if the deal closes mid-year. 7. **Ignoring the target's existing debt.** If it is refinanced, its interest is replaced by acquisition debt interest; if it is assumed, its interest stays in the target's net income. 8. **Using P/E on different earnings definitions** (trailing versus forward, adjusted versus reported) in the quick test. 9. **Treating the issue price as fixed.** A share price drop after announcement raises the number of shares under a fixed-value offer. ## Self-test questions 1. An acquirer trades at 20x earnings and pays 25x for a target, all in stock. Accretive or dilutive before synergies? Explain with earnings yields. 2. New debt costs 7% pre-tax and the tax rate is 25%. The target is bought at 12x earnings, all in debt. Accretive or dilutive before amortisation and synergies? 3. An acquirer has net income USD 50m, 25m shares and a share price of USD 40. It buys a target with net income USD 6m for USD 160m in stock. Compute the pro forma EPS, the accretion and the pre-tax synergies needed to break even (tax 25%). 4. Why do many acquirers report an EPS that excludes amortisation of acquired intangibles? What is the risk? 5. An acquirer with 100m shares issues 20m shares on 1 July to buy a target. What weighted average share count enters that year's basic EPS under IAS 33? 6. Give two reasons why accretion should not be the decision rule for an acquisition. 7. Rank cash on hand, new debt and new stock by their usual after-tax earnings cost, and explain why. 8. In a stock deal the target's holders will own 30% of the combined company but contribute 25% of its net income. What does that suggest? 9. An acquirer has net debt USD 900m and EBITDA USD 300m. It borrows USD 600m to buy a target with EBITDA USD 100m. What is pro forma net debt to EBITDA? 10. Under a fixed exchange ratio, what happens to the value received by the target's holders if the acquirer's share price falls 10% before closing? Who bears that risk? ## My notes and next steps | Item | My entry | |---|---| | The term I confuse most (adjusted versus reported EPS, cost of cash, share count) | [ ] | | Merger model I rebuilt and its check figure | [ ] | | Mistakes logged in mba/mba-error-log | [Date and short description] | | Flashcards added in mba/mba-concept-flashcards | [ ] | | Next review date | YYYY-MM-DD | ## Sources and further reading - IFRS Foundation. IAS 33 *Earnings per Share* (amended by IFRS 18 in April 2024 on additional per-share amounts) and IFRS 3 *Business Combinations*, ifrs.org (checked 2026-10-28). US GAAP equivalents: ASC 260 and ASC 805 (check the FASB Codification). - Myers, S. C., and Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. *Journal of Financial Economics*, 13(2), 187-221. - Travlos, N. G. (1987). Corporate takeover bids, methods of payment, and bidding firms' stock returns. *The Journal of Finance*, 42(4), 943-963. - Rappaport, A., and Sirower, M. L. (1999). Stock or cash? The trade-offs for buyers and sellers in mergers and acquisitions. *Harvard Business Review*, 77(6). - Fuller, K., Netter, J., and Stegemoller, M. (2002). What do returns to acquiring firms tell us? Evidence from firms that make many acquisitions. *The Journal of Finance*, 57(4), 1763-1793. - Shleifer, A., and Vishny, R. W. (2003). Stock market driven acquisitions. *Journal of Financial Economics*, 70(3), 295-311. - Textbooks (by name only): Rosenbaum, J., and Pearl, J., *Investment Banking: Valuation, LBOs, M&A, and IPOs*; Bruner, R. F., *Applied Mergers and Acquisitions*; Koller, T., Goedhart, M., and Wessels, D., *Valuation*. - Open resource: OpenStax, *Principles of Finance* (2022), free online at https://openstax.org, for EPS, P/E and cost of capital background (check the licence on the book page). ## Answer key **Worked example B.** Quick test: R's P/E (18.0x) is above the P/E paid (16.2x), so the all-stock deal is **accretive** before amortisation. New shares = 486 / 27 = **18.0m** (`=486/27`). Pro forma EPS = 180 / 118 = **1.5254**, accretion **+1.69%** (`=(180/118)/1.5-1`). With amortisation: (180 - 9) / 118 = **1.4492**, accretion **-3.39%** (`=((180-12*0.75)/118)/1.5-1`). Amortisation changes the sign: reported EPS is dilutive. Tell the board that the deal is accretive on cash EPS, dilutive on reported EPS, and that neither says whether the 35% premium is covered by synergies. **Self-test.** 1. Dilutive. Each new share costs 1/20 = 5.00% of earnings and buys 1/25 = 4.00%. 2. Accretive. After-tax debt costs 7% x 0.75 = 5.25%; the target yields 1/12 = 8.33%. 3. New shares = 160 / 40 = 4.0m. Pro forma EPS = (50 + 6) / 29 = **1.9310** against 2.00, **-3.45%** (`=(56/29)/2-1`). Break-even pre-tax synergies = (2.00 x 29 - 56) / 0.75 = **USD 2.67m** (`=(2*29-56)/0.75`). 4. Amortisation of acquired intangibles is a non-cash charge created by the deal's accounting, and the buyer may also be investing to maintain those assets; excluding it helps compare with organic growth. The risk is that adjusted EPS hides the full price paid, and that the same intangibles need real spending to keep their value. 5. 100 + 20 x 6/12 = **110m** shares. 6. It ignores the premium relative to synergies, and it ignores the risk added by debt or the dilution of control by stock. Cheap debt makes almost any cash deal accretive. 7. Usually cash on hand (forgone interest after tax, lowest), then new debt (interest after tax), then stock (earnings yield, highest unless the acquirer's P/E is very high). The order can change when interest rates are high or the acquirer's P/E is very high. 8. The acquirer is giving away a larger share of ownership than the earnings it receives: it is paying a premium in shares, which synergies must cover. 9. (900 + 600) / (300 + 100) = **3.75x**. 10. The number of shares is fixed, so the value received falls about 10%. The target's holders bear that price risk; a fixed-value offer (floating ratio) moves it to the acquirer's holders. See mba/mba-deal-structuring-card. ## Revision history | Version | Date | Author | Change summary | |---|---|---|---| | 0.1 | YYYY-MM-DD | [Your name] | Card set up from the template | | 0.2 | YYYY-MM-DD | [Your name] | *Example:* Rebuilt example A in Excel, added the reported EPS case | ## Standard and licence note Based on the definition of earnings per share in IAS 33 *Earnings per Share* and the acquisition method in IFRS 3 *Business Combinations* (IFRS Foundation; US GAAP equivalents ASC 260 and ASC 805), summarised in original words with standard numbers only, and on the published research on payment form and signalling cited above. The text, the fictional deals, all numbers and all questions are original; no textbook, case or standard text is copied. The template is independent and not affiliated with or endorsed by any business school, standard setter or publisher. Check the current official versions of the standards before you rely on them. Template licence: MIT.