Accretion / Dilution Analysis: The Two Methods You Need to Know

Accretion / Dilution Framework

Every M&A deal is a trade. If the earnings you buy exceed what you paid, the acquisition is accretive. If not, it's dilutive.

Two testing methods: Yield Method (compare returns vs. costs) and EPS Method (compare earnings per share before vs. after). Both are core to merger model analysis.

---

Quick Reference

Yield Method

Flip the target's P/E to get earnings yield:

$$\text{Earnings Yield}=\frac{1}{\text{P/E}}$$

20x P/E = 5% yield. Compare this against your acquisition currency cost.

---

EPS Method

The method used in actual merger models. Calculate pro forma earnings per share after the deal.

$$\text{Pro Forma EPS}=\frac{\text{Combined Net Income}\pm \text{Adjustments}}{\text{Pro Forma Shares}}$$

Rule: Pro Forma EPS > Prior EPS → Accretive

LBO Considerations

In a Leveraged Buyout, PE funds maximize debt because:

• Debt sits on target's balance sheet, not theirs
• Interest is tax-deductible
• Equity returns get leveraged up

Debt is cheap money that someone else (the target) repays. Loading 5% debt to buy a business returning 15% amplifies your equity return beyond 15%.

For debt paydown and IRR mechanics, see Paper LBOs.

---

Core Principle

For EPS calculation reference, see M&A Math Cheat Sheet: EPS Method.

Both methods answer one question: