Module 17: Accretion / Dilution Analysis

When a US corporation announces an acquisition, fundamental analysts immediately build an Accretion/Dilution Model to answer one brutal question: Will this deal cause the acquiring company's Earnings Per Share (EPS) to go up or down next year?

1. The Math of the Deal

A company can fund an acquisition using three methods: Cash on hand, issuing new Debt, or issuing new Stock. Each has a specific cost:

• Cost of Cash: Foregone interest you would have earned in the bank.
• Cost of Debt: The interest rate paid on the new bonds.
• Cost of Equity: The reciprocal of the P/E ratio (Earnings Yield).

2. Accretive vs. Dilutive

• Accretive: The acquired company's profits exceed the cost of the financing. The acquiring firm's EPS mathematically increases. (Wall Street cheers; the stock rises).
• Dilutive: The cost of the debt/equity issued to buy the target exceeds the target's profits. The acquiring firm's EPS mathematically drops. (Wall Street panics; the stock drops).

Self-Reflection & Assessment

1. If a company acquires a target purely using new Debt, what specific expense determines if the deal is Accretive or Dilutive?
2. Why does issuing massive amounts of new stock to fund an acquisition typically result in a "Dilutive" EPS outcome?