Accretion/Dilution Analysis Explained Simply (With Worked Example)

Accretion/dilution analysis is one of the most commonly tested M&A concepts in investment banking interviews. It answers a simple question: after the acquisition, does the acquirer's Earnings Per Share go up or down? If EPS increases, the deal is accretive. If it decreases, it's dilutive.

It sounds straightforward, but interviewers love testing the nuances. This guide gives you the concept, the quick test, and a full worked example.

The Core Concept

When a company acquires another, the combined entity has new total earnings and potentially new total shares outstanding. The question is whether the earnings gained from the target outweigh the cost of the acquisition.

In an all-stock deal, the acquirer issues new shares to pay for the target. More shares outstanding means existing shareholders own a smaller piece. But if the target brings enough earnings, EPS can still go up.

In an all-cash deal, the acquirer uses cash (or borrows). No new shares, but the company loses interest income on the cash spent or pays interest on the debt raised. The earnings impact depends on whether the target's earnings exceed the financing cost.

The Quick P/E Test

For all-stock deals, there's a simple shortcut:

If the target's P/E < acquirer's P/E → accretive. The acquirer is paying less per unit of earnings than the market values its own earnings. You're buying 'cheap' earnings relative to your own.

If the target's P/E > acquirer's P/E → dilutive. You're paying more per unit of earnings than your own are worth. Expensive acquisition.

Think of it in terms of earnings yields: if the target's earnings yield (E/P) is higher than the acquirer's, the deal is accretive. You're buying something that generates more return per pound than your own stock.

Worked Example: Step by Step

Let's say Company A (acquirer) buys Company B (target) in an all-stock deal.

	Company A (Acquirer)	Company B (Target)
Share Price	£40	£20
Shares Outstanding	10 million	5 million
Net Income	£20 million	£5 million
EPS	£2.00	£1.00
P/E Ratio	20x	20x

Assume Company A offers a 25% premium, so the offer price is £25 per share for Company B.

Step 1: Calculate Purchase Price

Purchase Price = Offer Price × Target Shares = £25 × 5m = £125m

Step 2: Calculate New Shares Issued

Since this is all-stock, Company A issues shares at its own price: £125m / £40 = 3.125 million new shares.

Step 3: Calculate Combined EPS

Combined Net Income = £20m + £5m = £25m

Combined Shares = 10m + 3.125m = 13.125m

Combined EPS = £25m / 13.125m = £1.90

Step 4: Accretive or Dilutive?

Company A's standalone EPS was £2.00. Combined EPS is £1.90. The deal is dilutive by £0.10 per share, or 5%.

Why? Both companies had the same P/E (20x), but Company A paid a 25% premium. The premium makes the effective P/E of the target 25x (paying £125m for £5m of earnings), which is higher than Company A's own P/E of 20x.

What If There Are Synergies?

Suppose the deal generates £3m of annual cost synergies (after tax). New combined Net Income = £25m + £3m = £28m. New EPS = £28m / 13.125m = £2.13. Now the deal is accretive by £0.13 per share. Synergies turned a dilutive deal into an accretive one.

Impact of Deal Structure

All-Cash (Funded by New Debt)

No new shares issued. Combined earnings = acquirer earnings + target earnings – after-tax interest on new debt. If target's earnings > after-tax interest cost, it's accretive.

All-Cash (Funded by Existing Cash)

Combined earnings = acquirer earnings + target earnings – forgone after-tax interest income on the cash used. Usually a smaller hit than debt financing.

Mixed Deal Structure

Pro-rata combination of the above effects. The more cash you use, the fewer new shares but the higher the financing cost.

Why Accretion/Dilution Isn't Everything

A deal can be dilutive in Year 1 but accretive by Year 3 as synergies ramp up. Many strategically excellent deals are initially dilutive. Boards and shareholders accept short-term dilution if the long-term value creation is compelling. Interviewers want to hear that you understand this nuance – accretion/dilution is one metric, not the only metric.

Common Interview Questions

Q: Is this deal accretive or dilutive? A: Compare combined EPS to standalone acquirer EPS. If higher, accretive. If lower, dilutive.

Q: What makes a deal more likely to be accretive? A: Lower target P/E relative to acquirer, more cash in the deal structure (lower financing costs), larger synergies, and lower premium paid.

Q: A company with a 15x P/E acquires a company with a 10x P/E in an all-stock deal. Accretive or dilutive? A: Accretive (before any premium). The target is cheaper on a P/E basis.

Q: Can a dilutive deal still be a good deal? A: Absolutely. If it's strategically important, if synergies make it accretive over time, or if the target has high growth potential that isn't reflected in current earnings.