Two companies can buy the same target at the same price and report opposite earnings effects. Financing mix, not the target, drives that divergence, and the exam tests it every cycle.
Companies pass through start-up, growth, maturity, and decline. Each stage carries its own revenue growth, free cash flow, business risk, and debt capacity. Managers rarely accept the decline stage passively. They act, and every action falls into one of three buckets.
- Investment: actions that increase size or scope, meaning inorganic growth, not capital expenditure or research and development.
- Divestment: actions that reduce size or scope by shedding slower-growing, lower-margin, or riskier operations.
- Restructuring: actions that leave size and scope unchanged but improve the cost structure or the financing structure.
Issuer-specific motivations for investment are synergies, growth, capabilities and resources, and an undervalued target. Synergies mean the combination is worth more than the sum of the parts. Cost synergies come from economies of scale, such as one headquarters instead of two. Revenue synergies come from economies of scope, such as cross-selling insurance to banking customers.
Common mistakes
- Judging a deal by the announcement return. A 45% one-day drop signals a fit problem, not proven value destruction; announcement reaction shows no correlation with returns two or more years out.
- Forgetting the tax shield on new interest. Deducting the full $120 million pretax interest in Example 1 instead of $90 million after tax turns $2.075 EPS into $2.00 and hides the accretion.
- Adding equity-method income to EBITDA. An equity investment or joint venture contributes one after-tax line to net income only. Loading its EBITDA into the denominator understates net debt to EBITDA.
Bottom line
- Three categories: investment increases size, divestment decreases it, restructuring improves cost or financing without changing scope
- Nine types: equity investment, joint venture, acquisition; sale, spin off; cost restructuring, balance sheet restructuring, reorganization; the LBO blends all three
- Top-down drivers are asset prices (pro-cyclical, roughly 0.80 correlation with equity indexes) and industry shocks
- Initial evaluation asks what, why, is it material, and when; materiality is size plus fit, with 10% of enterprise value the large-deal threshold
Exam shortcut
Before touching the numbers, classify the action: investment, divestment, or restructuring, then name which of the nine types it is. That classification alone answers many qualitative items. For accretion, run the multiple test first and use the full pro forma only to confirm. Stock deal: compare P/E paid against acquirer P/E. Cash or debt deal: compare the target's earnings yield against the after-tax cost of debt, never the pretax rate.
The full lesson (about 3,052 words, 20 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- corporate restructuring
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