{"id":20290,"date":"2019-04-04T09:00:19","date_gmt":"2019-04-04T14:00:19","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/kb\/%kb_category%\/accretion-dilution-rules-of-thumb-for-merger-models-1324\/"},"modified":"2024-09-11T07:05:34","modified_gmt":"2024-09-11T12:05:34","slug":"eps-accretion-dilution","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/eps-accretion-dilution\/","title":{"rendered":"EPS Accretion Dilution &#8211; Rules of Thumb for Merger Models (13:24)"},"content":{"rendered":"<p><div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">EPS Accretion Dilution - Rules of Thumb for Merger Models<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/eps-accretion-dilution\/#Why_Do_We_Care_About_Rules_of_Thumb_for_Determining_EPS_Accretion_Dilution_in_Merger_Models\">Why Do We Care About Rules of Thumb for Determining EPS Accretion Dilution in Merger Models?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/eps-accretion-dilution\/#EPS_Accretion_Dilution_Rules_of_Thumb_for_Merger_Models\">EPS Accretion Dilution Rules of Thumb for Merger Models<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/eps-accretion-dilution\/#Limitations_for_the_EPS_Accretion_Dilution_Rules\">Limitations for the EPS Accretion Dilution Rules<\/a><\/li><\/ul><\/nav><\/div>\n<br \/>\nHere&#8217;s an outline of what we cover in the lesson, and the step-by-step process you can follow to figure this out for yourself:<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Why_Do_We_Care_About_Rules_of_Thumb_for_Determining_EPS_Accretion_Dilution_in_Merger_Models\"><\/span>Why Do We Care About Rules of Thumb for Determining EPS Accretion Dilution in Merger Models?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>It&#8217;s a VERY common interview question &#8211; &#8220;How can you tell whether an M&amp;A deal is accretive or dilutive?&#8221;<\/p>\n<p>People often believe, incorrectly, that there&#8217;s no way to tell without building the entire model.<\/p>\n<p>But shortcuts always exist!<\/p>\n<p>Plus, this shortcut is very useful in real life. You can use it to &#8220;sanity check&#8221; your model, approximate the impact of a deal in advance, and so on.<\/p>\n<p>So it&#8217;s a time-saver *and* a good way to check your work.<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"EPS_Accretion_Dilution_Rules_of_Thumb_for_Merger_Models\"><\/span>EPS Accretion Dilution Rules of Thumb for Merger Models<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><strong>CONCEPT:<\/strong> An M&amp;A deal is accretive if the combined company&#8217;s <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/earnings-per-share-formula\/\" target=\"_blank\" rel=\"noopener\">EPS (Earnings Per Share)<\/a> is higher than the buyer&#8217;s standalone EPS prior to the transaction.<\/p>\n<p>It&#8217;s dilutive if the combined EPS is lower, and it&#8217;s neutral if the EPS is the same afterward.<\/p>\n<p>The outcome depends on price paid for the seller, the method of payment (cash, stock, or debt), the interest rate on debt and cash, and the buyer&#8217;s P\/E multiple, among other factors.<\/p>\n<p>In real life, it&#8217;s very difficult to tell with high precision whether the deal will be accretive or dilutive without running the whole model &#8211; due to added costs, revenue and <a href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/cost-synergies\/\" target=\"_blank\" rel=\"noopener\" data-schema-attribute=\"\">cost synergies<\/a>, write-ups, timing differences, the cumulative impact of additional interest on debt and foregone interest on cash, etc&#8230;<\/p>\n<p>BUT you can approximate the impact with a simple rule of thumb:<\/p>\n<p><strong>1) Calculate<\/strong> the Weighted &#8220;Cost&#8221; of Acquisition for the Buyer.<\/p>\n<p>You need to calculate the after-tax &#8220;cost&#8221; of each component, since Net Income is also after-tax.<\/p>\n<p><strong>After-Tax Cost of Cash<\/strong> = Foregone Cash Interest Rate * (1 &#8211; Buyer&#8217;s Tax Rate)<\/p>\n<p><strong>After-Tax Cost of Debt<\/strong> = Interest Rate on Debt * (1 &#8211; Buyer&#8217;s Tax Rate)<\/p>\n<p><strong>After-Tax Cost of Issuing Stock<\/strong> = 1 \/ Buyer&#8217;s P\/E Multiple (i.e., take the reciprocal of the buyer&#8217;s P\/E multiple)<\/p>\n<p>That last one is effectively the buyer&#8217;s &#8220;after-tax yield.&#8221;<\/p>\n<p>For example, if you buy 1 share of the buyer&#8217;s stock, it&#8217;s the Net Income you&#8217;d be entitled to with that 1 share.<\/p>\n<p>So, in this example shown in this video, 1 \/ Buyer&#8217;s P\/E Multiple = 1 \/ 11.3 x = 8.9%.<\/p>\n<p>That means that for each $1.00 of United stock you buy, you get $0.089 in Net Income.<\/p>\n<p>Finally, you calculate the Weighted Average Itself with this formula:<\/p>\n<p><strong>Weighted Average Cost of Acquisition<\/strong> = Cost of Cash * % Cash Used + Cost of Stock * % Stock Used + Cost of Debt * % Debt Used<\/p>\n<p><strong>2) Compare<\/strong> the Weighted Cost of Acquisition to the Seller&#8217;s &#8220;Yield&#8221; AT its purchase price (i.e. Seller&#8217;s Net Income \/ Equity Purchase Price).<\/p>\n<p>This step is essential &#8211; if the seller is currently valued at $900 million and the buyer pays $1 billion for the seller, you NEED to use the $1 billion actually paid for the seller or these yields won&#8217;t be correct.<\/p>\n<p><strong>3) If the Seller&#8217;s &#8220;Yield&#8221; is higher, it&#8217;s accretive<\/strong>. Otherwise, if it&#8217;s lower, it&#8217;s dilutive.<\/p>\n<p>Think of it as the buyer getting MORE *from* the seller than what it&#8217;s paying for the seller, vs. getting LESS than what it&#8217;s paying.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Limitations_for_the_EPS_Accretion_Dilution_Rules\"><\/span>Limitations for the EPS Accretion Dilution Rules<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>This trick doesn&#8217;t hold up if the tax rates for the buyer and seller are different, especially if they&#8217;re VERY different, such as 50% vs. 25% or 30% vs. 10%.<\/p>\n<p>This also doesn&#8217;t work if you also factor in write-ups \/ write-downs, <a href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/cost-synergies\/\" target=\"_blank\" rel=\"noopener\">cost synergies<\/a>, the cumulative impact of interest paid on debt and foregone interest on cash, merger closing costs, integration costs, etc.<\/p>\n<p>And it also doesn&#8217;t work if the acquisition closes mid-year or in between fiscal years &#8211; you need to adjust for that with stub periods and the calendarization of financials.<\/p>\n<p>But this is a common interview question, so who cares! It&#8217;s still very useful to know, and will save you a lot of time in interviews and on the job.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Learn about rules of thumb you can use to determine whether an acquisition will be accretive or dilutive in advance, based on the P\/E multiples of the buyer and seller, the % cash, stock, and debt used, and the prevailing interest rates on cash and debt.<\/p>\n","protected":false},"featured_media":0,"template":"","class_list":["post-20290","biws_kb","type-biws_kb","status-publish","hentry","kb_category-ma-and-merger-models"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/20290","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=20290"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}