Original questions written against the published FINRA and NASAA exam content outlines — not actual exam questions. Every choice is explained.
As a rule of thumb, an all-stock acquisition with no assumed synergies is generally accretive to the acquirer's EPS when:
- 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.
- 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.
- 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.
- 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.
Bellcross Corp (net income $80M, 40M shares, standalone EPS $2.00) acquires fictional target Fenwick Ltd (net income $20M, 10M shares) in an all-stock deal at an exchange ratio of 0.5 Bellcross shares per Fenwick share, with no synergies assumed. What is the pro forma EPS, and is the deal accretive or dilutive?
- A.$2.50 EPS; accretiveWrong. This divides combined net income by the original 40M shares, ignoring the 5M newly issued shares.
- B.$1.82 EPS; dilutiveWrong. This does not correctly apply the combined net income and pro forma share count.
- C.$2.22 EPS; accretiveCorrect. $100M ÷ 45M ≈ $2.22, above the $2.00 standalone EPS, so the deal is accretive.
- D.$2.00 EPS; neutralWrong. Combining the two companies' earnings and shares does move EPS; it does not leave it unchanged.
Why: New shares issued = 10M Fenwick shares × 0.5 exchange ratio = 5M shares. Pro forma shares = 40M + 5M = 45M. Combined net income (no synergies) = $80M + $20M = $100M. Pro forma EPS = $100M ÷ 45M ≈ $2.22, which is above Bellcross's $2.00 standalone EPS — the deal is accretive.
A precedent transaction multiple typically embeds a premium that a pure trading comparable does not, beyond the general control premium, because a strategic acquirer in a past deal:
- A.Was required by FINRA to overpay for regulatory reasonsWrong. There is no such FINRA requirement; deal pricing reflects negotiation, not a regulatory mandate.
- B.May have priced in expected synergies specific to that acquirer, which a public trading price does not reflectCorrect. Anticipated synergies specific to the acquirer are a real driver of the premium embedded in precedent deal multiples.
- C.Always used a different accounting standard than the targetWrong. Accounting standards do not explain a valuation premium.
- D.Was contractually obligated to pay the target's asking priceWrong. Deal price is negotiated, not contractually fixed in advance by the target's ask.
Why: A strategic buyer often paid up not just for control but for specific synergies it expected to realize by combining the businesses — cost savings, cross-selling or other benefits unique to that acquirer. A public market trading price reflects no such acquirer-specific synergy expectations.