If a deal involves cash and debt, what should you compare to assess accretion?

If a deal involves cash and debt, what should you compare to assess accretion?

• A. Seller's Pre-Tax Income vs sum of interest expense on debt and foregone interest on cash
• B. Purchase price vs seller's market cap
• C. Dividend yields
• D. Terminal value vs equity value

Answer: (A)

When a deal is financed with cash and debt, accretion comes down to whether the target’s earnings before tax can cover the financing costs. You look at the target’s pre-tax income and compare it to the sum of two costs: the interest expense on the new debt and the foregone interest from using cash (the opportunity cost of tying up cash you could have invested). If the target’s pre-tax income is higher than those financing costs, the deal adds to pre-tax earnings (accretive); if not, it’s dilutive. For example, if the target delivers $50 million of pre-tax income, debt interest costs $8 million, and foregone cash interest is $6 million, the financing costs total $14 million. The result is $36 million of pre-tax incremental earnings, which is accretive. Other options don’t specifically measure how the financing mix (cash plus debt) affects earnings: they relate to valuation comparisons, dividend yields, or long-term value versus equity value, none of which directly capture the financing cost versus target earnings framework used for accretion analysis.

When a deal is financed with cash and debt, accretion comes down to whether the target’s earnings before tax can cover the financing costs. You look at the target’s pre-tax income and compare it to the sum of two costs: the interest expense on the new debt and the foregone interest from using cash (the opportunity cost of tying up cash you could have invested). If the target’s pre-tax income is higher than those financing costs, the deal adds to pre-tax earnings (accretive); if not, it’s dilutive.

For example, if the target delivers $50 million of pre-tax income, debt interest costs $8 million, and foregone cash interest is $6 million, the financing costs total $14 million. The result is $36 million of pre-tax incremental earnings, which is accretive.

Other options don’t specifically measure how the financing mix (cash plus debt) affects earnings: they relate to valuation comparisons, dividend yields, or long-term value versus equity value, none of which directly capture the financing cost versus target earnings framework used for accretion analysis.