Accretion/Dilution

Instead of a stock deal, Bellcross Corp acquires Fenwick Ltd (net income $20M) for $150 million in cash, financed entirely with new debt at a 6% interest rate. Bellcross's tax rate is 25%, its share count stays at 40 million (no new shares issued), and its own net income is $80 million. What is the pro forma EPS, and is the deal accretive or dilutive?

1. A.$2.50 EPS; accretiveWrong. This ignores the new after-tax interest expense on the debt used to fund the deal.
2. B.$1.86 EPS; dilutiveWrong. This does not correctly combine net income, interest cost and the unchanged share count.
3. C.$2.33 EPS; accretiveCorrect. ($80M + $20M − $6.75M) ÷ 40M ≈ $2.33, above the $2.00 standalone EPS.
4. D.$2.33 EPS; dilutiveWrong. The EPS figure is correct, but $2.33 is above the $2.00 standalone EPS, which makes the deal accretive, not dilutive.

Why: After-tax interest cost on the new debt = $150M × 6% × (1 − 0.25) = $6.75M. Combined net income = $80M + $20M − $6.75M = $93.25M. Since no new shares are issued in a cash deal, pro forma EPS = $93.25M ÷ 40M ≈ $2.33, above the $2.00 standalone EPS — the deal is accretive, because Fenwick's earnings yield ($20M ÷ $150M ≈ 13.3%) exceeds the after-tax cost of the debt used to fund the deal (4.5%).

As a rule of thumb, an all-stock acquisition with no assumed synergies is generally accretive to the acquirer's EPS when:

1. A.The target's P/E multiple is higher than the acquirer's P/E multipleWrong. This is backwards — a higher target P/E relative to the acquirer's tends to be dilutive, not accretive.
2. B.The two companies' P/E multiples are exactly equalWrong. Equal P/E multiples, with no premium and no synergies, tend to produce a roughly neutral result, not clear accretion.
3. C.The acquirer's P/E multiple is higher than the target's P/E multipleCorrect. This is the standard rule-of-thumb condition for accretion in a no-premium, no-synergy all-stock deal.
4. D.The acquirer's share price is higher than the target's share price in absolute dollar termsWrong. Absolute share price levels are irrelevant to accretion/dilution; the relevant comparison is the P/E multiples.

Why: When the acquirer's P/E multiple is higher than the target's, the acquirer is effectively "buying" a dollar of target earnings for fewer of its own (relatively expensive) shares than a dollar of its own earnings would cost — which mechanically tends to raise pro forma EPS, before considering any premium paid or synergies.

For a fixed total deal value paid in acquirer stock, which of the following, holding everything else constant, makes an all-stock acquisition MORE likely to be accretive to the acquirer's EPS?

1. A.A lower acquirer share priceWrong. A lower share price requires MORE new shares to deliver the same fixed dollar value, increasing dilution.
2. B.A higher exchange ratioWrong. A higher exchange ratio means more acquirer shares issued per target share, which increases dilution.
3. C.A higher acquirer share price, requiring fewer new shares for the same total deal valueCorrect. Fewer shares issued for the same dollar value reduces dilution and supports accretion.
4. D.A longer post-closing integration timelineWrong. Integration timeline does not enter the mechanical pro forma EPS calculation at closing.

Why: If the total dollar value of stock consideration is fixed, a higher acquirer share price means fewer new shares must be issued to deliver that same dollar value — less share dilution, which supports accretion, all else equal.

True or False: An acquisition that is accretive to the acquirer's pro forma EPS is, by itself, proof that the deal creates shareholder value.

1. A.TrueWrong. EPS accretion is a mechanical result of the combined income and share count; it does not confirm the price paid was justified.
2. B.FalseCorrect. A deal can be EPS-accretive — especially if financed cheaply — while still overpaying relative to the target's intrinsic value.

Why: EPS accretion is purely a mechanical result of combined earnings and share (or financing) counts. It says nothing about whether the price paid is justified by the target's intrinsic value, the deal's return on invested capital, or the risk taken on — a deal financed cheaply with debt can be EPS-accretive even if it substantially overpays for the target.