The Acquisition That Looked Accretive on Paper
A company with 40M diluted shares and $160M net income ($4.00 EPS) is considering acquiring a target for $500M in cash plus $100M of assumed debt. The target has EBITDA of $70M, D&A of $25M, and interest expense of $8M, giving pre-tax income of $37M. The acquirer can finance the $500M cash portion at 6.5% and expects $15M of annual cost synergies, phased 50% in year one. The deal also creates $180M of goodwill and identifiable intangibles that will amortize at $12M per year for tax and book purposes. The board's banker calls the deal 'accretive to EPS in year one.'
1. Test the banker's accretion claim for year one and steady state, showing the arithmetic.
Read the worked answer
Target standalone pre-tax: $37M; after ~25% tax ≈ $27.75M net.
Year-one adjustments:
- Financing cost: $500M x 6.5% = $32.5M pre-tax, ~$24.4M after tax.
- Synergies: 50% x $15M = $7.5M pre-tax, ~$5.6M after tax.
- Incremental intangible amortization: $12M pre-tax, ~$9M after tax (assume tax-deductible as stated).
- Note: target's existing $8M interest is already in its $37M; the new debt interest is additive.
Year-one incremental net income ≈ 27.75 + 5.6 − 24.4 − 9.0 ≈ −$0.05M - essentially neutral, not accretive.
Steady state (full synergies): 27.75 + 11.25 − 24.4 − 9.0 ≈ +$5.6M. On 40M shares that is ~$0.14, or ~3.5% accretion.
So the banker is roughly right only at full synergy run-rate, and year one is dilutive-to-flat.
2. The CFO is skeptical of relying on EPS accretion. What additional tests should drive the decision?
Read the worked answer
- Cash EPS / EPS before amortization: accretion improves if you exclude intangible amortization (~$0.23/share steady state), but that flatters a real economic cost only if the intangibles are genuinely wasting. Show both.
- Return on invested capital vs WACC: Invested capital ≈ $600M (cash + debt). Steady-state NOPAT ≈ (37 + 15) x 0.75 ≈ $39M, less the tax-effected amortization shield if excluded - ROIC roughly 6.5%, near or below a typical WACC. If ROIC < WACC, the deal destroys value even when 'accretive.'
- Synergy risk: 50% phasing assumes execution; stress at 60% realization.
- Goodwill impairment exposure: $180M of goodwill is a future write-down risk if the thesis fails.
- Financing risk: 6.5% is fixed assumption; a 100bp move costs ~$3.75M pre-tax.
Recommendation should hinge on ROIC vs WACC and strategic fit, not EPS optics.