Accretion/dilution analysis can show that an acquisition increases earnings per share while weakening debt repayment capacity. You need to assess earnings, valuation, and financing together.
Your client is the acquirer, the company buying another business. The company being purchased is the target. You use accretion/dilution analysis to determine whether the transaction increases earnings attributable to each existing acquirer share.
In accretion/dilution analysis, earnings per share (EPS) divides earnings available to common shareholders by the relevant weighted average common shares. Pro forma means showing financial results as though the transaction had occurred under specified assumptions.
Accretion occurs when combined EPS exceeds the acquirer's stand-alone EPS. Dilution occurs when combined EPS falls below that benchmark. Equal EPS is neutral.
Compare the same forecast period and accounting basis. Diluted EPS is an accounting measure that incorporates potentially dilutive securities, such as employee options, under applicable accounting rules. Transaction dilution is a separate idea: pro forma EPS falls below stand-alone EPS, and a deal can be accretive on a diluted-EPS basis.
Common mistakes
- Comparing combined net income instead of EPS. In Example 2, $106.4 million exceeds $100 million, yet $2.4744 EPS is dilutive.
- Using the unaffected target multiple. In Example 1, the $25 unaffected price implies $25 ÷ $2 = 12.5 times, but the $30 offer requires $30 ÷ $2 = 15 times.
- Adding revenue synergies directly to earnings. Example 2's $20 million additional sales contribute $5 million pretax profit.
Bottom line
- Accretion compares combined EPS with the acquirer's stand-alone EPS for the same period and basis.
- In a simplified all-stock deal, a higher acquirer P/E than the target's offer P/E produces accretion.
- Cash financing affects earnings through incremental interest expense or forgone interest income.
- Goodwill reflects acquisition value beyond separately recognized net assets.
Exam shortcut
Circle the consideration mix first. Put stock issuance beside the denominator and financing costs beside the numerator. Mark each earnings input “pretax” or “after tax” before calculating. Apply the tax rate only where needed. When the stem says “all stock, no adjustments,” compare purchase multiples before doing arithmetic. Use that direction to catch a reversed ratio. Keep unrounded EPS in your calculator until the final percentage.
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Learning objectives
- C23
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