Tax-Affecting Synergies in Accretion Math, Explained
The question
Why must synergies, new interest expense, and foregone interest on cash all be tax-affected before they hit pro-forma net income? Give the after-tax value of $60M of pre-tax synergies at a 25% rate.
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The answer
Synergies, new interest expense, and foregone interest on cash all sit above the tax line on the income statement, so they change pre-tax income, not net income directly. To get their real impact on earnings, I have to run each one through the tax provision at one minus the marginal tax rate. If I forget to tax-affect them, I am either overstating or understating pro-forma net income, and the accretion number will be wrong.
For example, $60 million of pre-tax synergies at a 25% rate adds only $45 million to net income; that is the after-tax value. The same logic applies to new interest expense, which is tax-deductible, and to foregone interest on cash, where the true opportunity cost is the after-tax yield we give up. So every time I build that pro-forma net income line, I force myself to say “after-tax” out loud.
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% |
Also asked as
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- Distinguish GAAP EPS from cash EPS in a merger model. What line item drives the wedge between them, why is it non-cash, and why do acquirers prefer to report cash EPS?
- Acquirer: $600M NI, 300M shares, $40 price, 25% tax. Target purchase equity value $2,000M funded 50% new debt at 5% and 50% stock; target NI $120M; pre-tax synergies $80M. Compute pro-forma EPS and accretion, then solve for the breakeven pre-tax synergy level at which the deal becomes EPS-neutral.
- An all-stock deal: acquirer trades at 18x, target's unaffected P/E is 12x. Solve for the maximum control premium (ignoring synergies) at which the deal remains accretive, and then explain how layering in $50M of pre-tax synergies changes that breakeven premium.
- An asset deal creates a $600M step-up in tax-deductible intangibles amortized over 10 years. Acquirer $500M NI, 250M shares, 25% tax, all-cash funded from cash yielding 2% pre-tax ($1,500M used), target NI $100M, no operating synergies. Compute both GAAP and cash EPS accretion/dilution and explain precisely why they diverge.
- A deal is 12% EPS-accretive, funded entirely by new debt at a 4% after-tax cost. Your MD asks whether the accretion means it's a good deal. Explain why EPS accretion is not the same as value creation, what you'd actually check to judge the deal, and construct a simple example of an accretive deal that destroys value.
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Accretion and dilution