M&A

Accretion / dilution

4 min read · updated June 29, 2026

Accretion/dilution answers one blunt question the acquirer's CFO and board care about: does this deal raise or lower our earnings per share? If pro-forma EPS (the combined company's EPS after the deal) goes up, the deal is accretive; if it goes down, it's dilutive. That's the whole test — it's an EPS sensitivity, run before anyone gets excited about strategic logic.

The build is a sequence, and interviewers want the sequence: combine the two companies' net incomes, add after-tax synergies, subtract the after-tax cost of financing the deal, then divide by the new pro-forma share count. Compare that to the acquirer's standalone EPS.

$\text{Pro-forma EPS} = \frac{\text{Acquirer NI} + \text{Target NI} + \text{Synergies} - \text{After-tax financing cost}}{\text{Acquirer shares} + \text{New shares issued}}$

Cash vs. stock — what changes the answer

The financing decides a lot, because each source has a different "cost" that eats into combined earnings:

Cash — funded off the balance sheet or new debt. The cost is the forgone interest on the cash or the after-tax interest on the new debt. With rates low relative to earnings yields, cash deals usually come out accretive.
Stock — the acquirer prints new shares to pay the seller. The cost is dilution of the share count. Whether it helps or hurts depends entirely on the relative P/E ratios.
Debt — like cash, the cost is after-tax interest; cheaper than equity, so it tends toward accretive.

The P/E rule of thumb

For an all-stock deal, there's a shortcut you should know cold:

Acquirer's P/E higher than the target's → the deal is accretive.
Acquirer's P/E lower than the target's → the deal is dilutive.

The intuition: a high-P/E acquirer is issuing "expensive" shares to buy "cheaper" earnings, so each new share brings in more income than it costs — EPS rises.

Common mistake

Two traps here. First, candidates apply the P/E rule to cash deals — it's an all-stock heuristic only; a cash deal's accretion hinges on interest rates and yields, not relative P/Es. Second, and bigger: people treat "accretive" as "good deal" and "dilutive" as "bad deal." Accretion/dilution measures EPS impact — it says nothing about whether the deal creates value. A company can do an accretive acquisition that destroys value (overpaying for declining earnings) or a dilutive one that's strategically brilliant. Don't conflate the EPS arithmetic with value creation.

A worked example

Acquirer earns $1,000** of net income on **1,000** shares → **$ 1.00 EPS. It buys a target earning $200 of net income, all in stock, issuing 150 new shares. Ignore synergies and assume an all-stock deal with no financing cost.

Pro-forma net income is $1,000 +$ 200 = ** $1,200**; pro-forma shares are 1,000 + 150 = **1,150**. Pro-forma EPS =$ 1,200 / 1,150 = ** $1.04**. EPS rose from$ 1.00 to $1.04 — the deal is accretive by about 4%. (Consistent with the rule of thumb: the acquirer's earnings yield was richer than the price it paid for the target's earnings.)

Key insight

The reason a CFO runs this first is optics and incentives: public-market investors and management comp both key off EPS, so a dilutive deal is a hard sell to the board even when it's strategically sound. The banker's job is to know the EPS answer and be able to separate it from the value question — because the two genuinely can point in opposite directions.

Interview tip

Walk the pro-forma EPS build in a fixed order every time: combine net incomes → add after-tax synergies → subtract after-tax financing cost → divide by the new share count → compare to standalone EPS. Saying it as a clean sequence, with the after-tax adjustments called out, is what reads as fluency in a merger model — far more than getting the last decimal right.

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