In a basic merger model, which step ultimately determines the combined earnings per share (EPS)?

In a basic merger model, which step ultimately determines the combined earnings per share (EPS)?

• A. Combine Income Statements and adjust for foregone interest, then compute EPS
• B. Step 1: making assumptions about acquisition price and financing
• C. Project each company's Income Statement
• D. Apply the target's tax rate

Answer: (A)

In a merger model, the thing that ultimately sets the combined EPS is the bottom-line result for the merged entity after accounting for financing and the new share count. EPS is net income divided by shares outstanding, so you need the merged net income and the post-merger number of shares to compute it. To get that merged net income, you combine the two income statements and adjust for financing effects from the deal, such as foregone interest (the opportunity cost of using cash versus debt) and the interest or tax effects of any new financing. Once you have the combined net income, you divide by the total shares outstanding after the merger to arrive at the EPS. The other steps are important setup: projecting each company’s income statement provides the data used in the merge, and assumptions about acquisition price and financing shape the financing structure, but they don’t themselves produce the final EPS. Applying the target’s tax rate is part of the adjustment process, but the final EPS still hinges on the merged net income and the post-merger share count.

In a merger model, the thing that ultimately sets the combined EPS is the bottom-line result for the merged entity after accounting for financing and the new share count. EPS is net income divided by shares outstanding, so you need the merged net income and the post-merger number of shares to compute it.

To get that merged net income, you combine the two income statements and adjust for financing effects from the deal, such as foregone interest (the opportunity cost of using cash versus debt) and the interest or tax effects of any new financing. Once you have the combined net income, you divide by the total shares outstanding after the merger to arrive at the EPS.

The other steps are important setup: projecting each company’s income statement provides the data used in the merge, and assumptions about acquisition price and financing shape the financing structure, but they don’t themselves produce the final EPS. Applying the target’s tax rate is part of the adjustment process, but the final EPS still hinges on the merged net income and the post-merger share count.