Accretive vs Dilutive: How to Test Any M&A Deal

The yield method compares the target's earnings yield (1/P/E) against the acquirer's cost of capital. For all-stock deals, if the acquirer's P/E exceeds the target's P/E at the offer price, the deal is accretive. For debt-financed deals, compare the target's earnings yield to the after-tax cost of debt.

The EPS method calculates pro forma earnings per share after the deal by combining both companies' net income, adjusting for after-tax interest on new debt, lost interest on cash, D&A from write-ups, and synergies, then dividing by pro forma shares outstanding. If pro forma EPS exceeds the acquirer's standalone EPS, the deal is accretive.

Multiply the stock portion by the acquirer's earnings yield (1/P/E) and the debt portion by the after-tax interest rate, then sum them. For example, a 50/50 stock-debt deal with a 20x P/E acquirer and 6% debt at 25% tax gives a weighted cost of (0.5 x 5%) + (0.5 x 4.5%) = 4.75%. The deal is accretive if the target's yield exceeds this.

In accretion/dilution, the cost of equity is the inverse of the acquirer's P/E ratio, not CAPM. CAPM calculates a theoretically correct discount rate for DCF valuation, while accretion analysis asks whether issuing stock dilutes or enhances EPS. Discussing beta and risk-free rates in an accretion question signals framework confusion.

Debt sits on the target's balance sheet, not the sponsor's, and the interest is tax-deductible, so it amplifies equity returns. Loading debt at a lower cost than the business's return (for example, 5% debt buying a business that returns 15%) pushes the equity return above that 15%.