The accretion shortcut: cost vs yield
“Without a model, how can you tell if a deal is accretive?”
This is the follow-up that separates strong candidates. It turns a long calculation into a ten-second comparison.
If the target earns more per dollar paid than the funding costs per dollar, EPS goes up.
Cost of each funding source (after tax)
Cash: the interest it would have earned × (1 − tax). Usually cheapest. Debt: the interest rate × (1 − tax). Stock: the buyer's earnings yield, 1 ÷ its P/E. Issuing shares at 20x earnings “costs” 5% of earnings per dollar raised.
What you're buying
The target's earnings yield at the price paid: its net income ÷ purchase price, or 1 ÷ the P/E you're paying. Pay 25x earnings and you're buying a 4% yield.
- 1Cost of stock = 1 ÷ 18 ≈ 5.6%. Cost of debt = 7% × 0.75 = 5.25%. Cost of cash = 3% × 0.75 = 2.25%.
- 2Target yield = 1 ÷ 16 = 6.25%.
- 3Every funding source costs less than 6.25%, so the deal is accretive however it's funded. All-cash is the most accretive.
Yield above cost → accretive. Yield below cost → dilutive.
Try changing the price paid.
For all-stock deals, it collapses to one line: accretive if the buyer's P/E is higher than the P/E it pays for the target.
Say it like this
I'd compare the after-tax cost of how the deal is funded with the target's earnings yield at the purchase price. Cash costs the interest it would have earned after tax, debt costs its after-tax interest rate, and stock costs the buyer's earnings yield, one over its P/E. If the weighted cost of the funding mix is below the target's net income divided by the purchase price, the deal is accretive, before synergies and other adjustments.
Traps to avoid
- ✕Comparing the cost of stock with the target's P/E as a cost. Stock's cost is the buyer's earnings yield.
- ✕Forgetting after-tax rates for cash and debt.
- ✕Ignoring synergies and write-up D&A when the question includes them; the shortcut is a first pass.
What they'll ask next
›Why is cash usually the cheapest?
The interest it earns is low, especially after tax, so giving it up costs little relative to the target's earnings.
›What happens to debt-funded deals when rates rise?
The after-tax cost of debt rises toward or above target yields, making them less accretive or dilutive.
›Can a low-P/E buyer do an accretive all-stock deal?
Only by buying a target at an even lower P/E, or with enough synergies to cover the gap.
Check yourself
The buyer trades at a P/E of 20x. What's its “cost” of paying with stock?
Put it all together
Price the deal, allocate the purchase price, and find out whether it lifts the buyer's EPS.