Finwonk
M&A: accretion/dilution5 min read

Accretion and dilution: does EPS go up?

The interview question

“Is this acquisition accretive or dilutive?”

Every strategic deal gets this question from the board and investors. Interviewers want you to know what goes into pro forma EPS and that accretion is not the same as a good deal.

The core idea

Pro forma EPS = (buyer's earnings + target's earnings ± deal effects) ÷ (buyer's shares + any new shares). Higher than before = accretive.

What changes when one company buys another

The buyer adds the target's net income. Then it pays for it, and payment has a cost: cash stops earning interest, debt adds interest expense, stock adds new shares to the denominator. Synergies add earnings; write-ups of the target's assets add depreciation and amortization.

Worked example
Buyer: net income $200, 100 shares (EPS $2.00), share price $30. Target earns $40 and costs $600. Tax 25%.
  1. 1All debt at 6%: after-tax interest = 600 × 6% × 0.75 = $27. Pro forma NI = 200 + 40 − 27 = $213 → EPS $2.13, about 6.5% accretive.
  2. 2All stock at $30: new shares = 600 ÷ 30 = 20. Pro forma EPS = 240 ÷ 120 = $2.00, breakeven.
  3. 3Why breakeven? The buyer trades at 15x earnings and pays 15x for the target: same price per dollar of earnings.
Same target, same price: the financing choice decides accretion.
Accretive or dilutive? Try it
Buyer EPS
$1.00 → $1.022
2.2% accretive
After-tax cost of what you pay with vs. what the target earns
Cash (lost interest)3.0%
Debt (after-tax rate)6.0%
Stock (1 ÷ buyer P/E)5.0%
Weighted cost of this mix5.5%
Target's earnings yield (its NI ÷ price paid)6.0%

Yield above cost → accretive. Yield below cost → dilutive.

Switch between cash, debt and stock, then change the buyer's P/E and the price paid.
Watch out

Accretion is an accounting result. A deal can raise EPS while destroying value (overpaying with cheap debt), or dilute EPS while creating value (buying a fast grower). Say this unprompted and you'll stand out.

Say it like this

To check accretion or dilution, I'd combine the buyer's and target's net income, then adjust for the costs of the deal: lost interest on cash used, after-tax interest on new debt, and extra depreciation and amortization from asset write-ups, plus any synergies. Then I'd divide by the buyer's share count plus any new shares issued. If pro forma EPS is higher than the buyer's standalone EPS, the deal is accretive; if lower, dilutive.

Traps to avoid

  • ✕Forgetting the financing cost: cash and debt aren't free, and stock adds shares.
  • ✕Adding the target's share count to the buyer's. Target shares are cancelled; only new buyer shares count.
  • ✕Equating accretive with good.

What they'll ask next

›Why might a value-creating deal be dilutive?

Buying a high-growth target at a high P/E, or one with little current profit, can lower near-term EPS while adding long-term value.

›What adjustments go into pro forma net income?

Forgone interest on cash, new interest expense, synergies, D&A from write-ups, and sometimes amortization of financing fees, all tax-effected.

›How much synergy would make a dilutive deal break even?

The net income shortfall divided by (1 − tax rate): a $15 shortfall at 25% tax needs $20 of pre-tax synergies.

Check yourself

Question 1 of 3

What does it mean for a deal to be “accretive”?

Put it all together

Atlas Outdoor × TrailPeak · 20 min case study
Should Atlas Outdoor buy TrailPeak?

Price the deal, allocate the purchase price, and find out whether it lifts the buyer's EPS.