If accretion is based on EPS, how does your purchase price affect that EPS? Isn't EPS your net income / shares outstanding? How does the purchase price affect this?
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Perhaps a better question:
If two companies are identical in every single way, same net income, same shares outstanding...and one buys the other, wouldn't it be accretive?
For example, company A and B both have $10 in NI, and 100 shares outstanding, their EPS is 0.1 Therefore, if you combined them, you would have 20 NI / 100 shares = 0.2
You are ignoring interest expense or shares issued here. Company A doesn't get B's net earnings for free.
what if they paid with all cash?
You have to finance the purchase price in some way. Either you take out more debt, which raises interest expense, which lowers earnings, and therefore EPS. Or you issue more shares, which increases your denominator, which lowers EPS.
what if it was all cash? I just dont see the connection between purchase price and EPS
Indirectly it affects consideration. If purchase price is low, generally firms will use cash vs when its very high, firms use more equity. The more cash used means more forgone interest income, more additional interest from the revolve/new debt, but this also means less dilution from new share. It can still be dilutive however.
okay so in my example, with both companies earning 10 in NI. Let's say the company pays in all cash. Let's say cash foregone interest rate is 10%, and they buy this company for $200. Therefore, foregone interest is $20*(1-40%) = 12 Now the combined income is (10-12) + 10 = 8 8/100 shares = 0.08, therefore if they pay $200 for this, its dilutive?
Is that how it works?
Correct
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