Investment Banking Technical Question - Dilution Analysis
**Questions:
1.) A company with a PE of 10 buys a company with a PE of 12 with 50% debt and 50% equity. Assume a 40% tax rate. What would be the cost of debt to make this neither Accretive nor dilutive?
2.) Company A has a share price of $25 and 1,000,000 shares outstanding buys Company B with 40% equity paying $15/share with 500,000 shares outstanding. Company A has a net income of $4,000,000 and company B has a net income of $1,000,000, cost of debt is 6% (40% tax rate), there is $250,000 (after tax) in hard synergies. Is this Accretive or dilutive? By how much?
**Answers
1.) *0.1 x 0.5 + (0.5)(1-0.4)x = 0.083, so cost of debt has to be 11%
2.) Company A EPS before the acquisition:
$4M/1M shares = 4 EPS.
Company A EPS after acquisition:
($4,000,000 + $250,000 - $405 000*)/1,500,000** = 3.1 EPS
Therefore, the deal is dilutive.
*Debt issued = ($15 x 500,000 shares/0.4) x 0.6 = $11,250,000
interest = $11,250,000 x 0.06 x (1-0.4) = $405,000
**1,000,000 shares + 500,000 issued*
- Isn't making the equation equal to 0.083 something that will make the deal accretive?
- Wouldn't you also have to add the earnings of company B to the 4M and 250k?
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