Combined EqV/Multiple in Merger
Hey all. Struggling with this technical:
Company A has market cap of 50 / NI of 5, Company B has market cap of 30 / NI of 1. Company A acquires B in a 100% debt deal with a 5% interest rate on debt. What is the combined P/E?
My thought process is that because it is all-debt, A's EqV stays the same so it remains 50. Add the NI's together = 6. Thus the P/E is 50/6 = 8.33x. However, whenever I see these types of questions, they seem to add the market caps together. Why would you do this and what is the right answer to this?
Based on the most helpful WSO content, here's how to approach this:
When calculating the combined P/E ratio in a merger scenario, the key is to understand how the equity value (EqV) and net income (NI) are affected by the transaction structure. In this case, since the deal is 100% debt-financed, the equity value of Company A does not change because no new equity is issued. The debt financing does not impact the equity value directly.
Step-by-Step Breakdown:
Equity Value (EqV):
Net Income (NI):
Combined P/E Ratio:
Why You Don’t Add Market Caps:
Adding market caps is only relevant if the transaction involves equity issuance (e.g., stock-for-stock deals). In an all-debt deal, the equity value of the acquirer remains unchanged, and the target's equity value is irrelevant post-acquisition.
Final Answer:
The combined P/E ratio is approximately 9.8x, not 8.33x. The key adjustment here is accounting for the after-tax interest expense from the debt used to finance the acquisition.
Sources: M&A Interview Questions - Beginner to Advanced Questions, Investment Banking Technical Q - M&A, M&A Interview Questions - Beginner to Advanced Questions, Two listed companies have the exact same Financial Statements, yet the P/E Multiple of company A is 2x the P/E of B. Why?, M&A Question Asked by PJT London
bump
I'm puzzled by any approach that combines the market caps. Imagine you own a house mortgage-free. Then you buy a second house entirely with debt (maybe markets are getting frothy). The equity of your portfolio doesn't change - obviously if the purchase was in shares you could combine equity values, but you're right in this case.
Only nuance that you might have missed with your answer is that the new debt doesn't pay for itself, so you need to subract the interest and adjust for tax.
good point on the NI and makes sense that you would not add the MC's together - thought that was the right intuition
Quia blanditiis ut in. Nobis ex culpa dolore.
Fuga eum necessitatibus autem voluptatem dicta. Iure ad ut ratione ea rerum necessitatibus ratione. Perferendis quo itaque animi. Repellendus nemo labore aut facilis amet. Et placeat doloremque molestiae ratione quis dolorem alias. Consequuntur et repellendus est ex nisi sunt.
Sed impedit minima sapiente deserunt nihil distinctio. In nihil qui amet eveniet rerum laudantium enim. Nisi animi sequi nulla repudiandae placeat eveniet impedit. Est esse nobis doloremque sapiente ipsa voluptatem ullam occaecati. Consequatur eaque tenetur incidunt totam quibusdam nihil a. Qui sit voluptatum laborum omnis.
Aut adipisci hic aperiam sint quod. Laudantium aperiam qui voluptatem corrupti itaque.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...