Financing Mix and Pro Forma EPS, Explained
The question
Walk me through how each of the three financing sources (cash on hand, new debt, and new stock) affects pro forma EPS, and where each one shows up in the accretion/dilution build.
M&AInterview question
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
The answer
Cash and debt hit the numerator by reducing pro forma net income after tax; stock hits the denominator by increasing diluted shares. Here is the walkthrough.
- Cash on hand. I use existing cash, so I issue no new shares. But that cash had been earning interest, and now that income disappears. In the build, I subtract foregone interest income multiplied by one minus the tax rate from pro forma net income. The impact is a smaller numerator.
- New debt. Again, no new shares. I borrow and incur interest expense, which is tax-deductible. In the build, I subtract the after-tax interest expense, new debt times the borrowing rate times one minus the tax rate, from net income. The numerator shrinks by that after-tax cost.
- New stock. Here the income statement is untouched. Instead, I issue new acquirer shares equal to the stock consideration divided by my share price. Those shares are added directly to the diluted share count in the denominator, and that dilution is the entire EPS effect. The cost is measured by my earnings yield. So cash and debt flow through the numerator as after-tax costs; stock flows through the denominator as new shares. Every adjustment must be after-tax to get the true EPS change.
Accretion / dilution
| Acquirer standalone net income | 300 |
| + Target net income | 80 |
| + After-tax synergies | 15 |
| − After-tax incremental interest | (10) |
| Pro forma combined net income | 385 |
| Acquirer standalone EPS | $3.00 |
| Pro forma share count | 125 |
| Pro forma EPS | $3.08 |
| Accretion | 2.7% |
Illustrative figures
Also asked as
- An acquirer trading at 18x P/E buys a target for 12x earnings in an all-stock deal with no synergies. Accretive or dilutive, and why does this shortcut work only for all-stock deals?
- Why do you multiply interest expense, foregone interest income, and synergies by (1 - tax rate) in the pro forma net income build?
- Acquirer: $400M net income, 100M shares, $80 share price. It buys a target with $60M of net income for $900M, all cash, funded with new debt at 6% pre-tax; tax rate 25%. Compute year-one accretion/dilution in percent.
- Rank cash, debt, and stock from cheapest to most expensive financing source for a typical acquirer, and describe a realistic scenario in which stock becomes the cheapest of the three.
- Your MD says: 'The deal is 8% accretive, so it's clearly a good deal.' Give the two-part pushback an elite-boutique analyst should be ready to deliver, including how you would test whether the premium paid is justified.
- Acquirer: EPS $3.00, share price $45, 300M diluted shares. Target: 150M shares at $20, acquired at a 40% premium, 60% stock / 40% new debt at 7.5%; target net income $250M; tax rate 25%. Compute pro forma EPS and the accretion/dilution percentage.
- A 100% debt-funded cash deal at a 9% pre-tax coupon and 21% tax rate is exactly EPS-neutral. What P/E did the acquirer pay for the target, and what happens to the breakeven P/E if the tax rate rises to 30%? Explain the direction intuitively.
- A deal is +5% accretive on management's 'cash EPS' but -2% dilutive on GAAP EPS. What deal items most likely explain the gap, which measure would you present to the board, and how would you defend that choice against a skeptical director?
- Mid-negotiation, rates rise and the acquirer's new-debt coupon moves from 5% to 8% while its P/E compresses from 22x to 16x (tax rate 25%). For a target being bought at 14x earnings, does the optimal financing shift toward stock or debt on pure year-one EPS math? Show the comparison.
Practice this topic with rubric-grounded grading inside IB Atlas.
Start freeGet all 125 practice prompts as one PDF.
General educational prompts with study explanations for offline review. They are not firm-provided or confidential questions.
Keep going
- Why is 'this deal is accretive' not the same statement as 'this is a good deal'? Give a one-sentence explanation an MD would accept.
- Costs to Achieve in M&A, Explained
- Bolt-On Acquisitions, Explained
- What happens to the target's existing goodwill and its historical equity accounts on the pro forma balance sheet, and why?
- Guide: M&A terms study guide
The rest of this topic
Accretion and dilution