What adjustments does a full pro-forma EPS build include?

Combine the two net incomes, then layer in after-tax synergies, after-tax incremental D&A from the purchase accounting step-up, after-tax interest on new debt, after-tax foregone interest on cash used, and any financing fee amortization. Divide by the acquirer's shares plus new shares issued. The step-up D&A is the adjustment candidates forget most often.

What is breakeven synergies?

The level of pre-tax synergies that makes pro-forma EPS exactly equal the acquirer's standalone EPS. You solve for the synergy number that closes the gap rather than testing values by trial. It is a favourite interview question because it tests whether you can rearrange the build rather than just run it forwards.

When does the P/E rule of thumb break down?

It assumes an all-stock deal with no synergies, no purchase accounting step-up, and no financing cost. Add meaningful synergies and a low-P/E buyer can still be accretive. Add a large step-up in depreciable assets and a high-P/E buyer can be dilutive. The rule is a first-order screen, not a conclusion.

M&A

Accretion / dilution (Advanced)

By Michael Song · Wharton MBA · ex-Greenhill · investment banking interview coach

5 min read · updated July 30, 2026

The basic version gives you the four-step build and the P/E shortcut. Level 4 and 5 questions add the adjustments that shortcut ignores, then ask you to solve the build backwards.

The full build

Every term below is after-tax, and forgetting to tax-effect any of them is the fastest way to lose the question.

$\text{PF EPS} = \frac{\text{NI}_A + \text{NI}_T + pS(1-t) - \Delta D\&A(1-t) - I_{\text{new}}(1-t) - I_{\text{foregone}}(1-t) - F(1-t)}{\text{Shares}_A + \text{Shares}_{\text{new}}}$

where $S$ is run-rate pre-tax synergies, $p$ is the share of them realized in the year you are measuring (phasing: often 30–50% in year one, $p = 1$ only at run-rate), and $F$ is financing fee amortization. The worked example below assumes $p = 1$ and $F = 0$ for clarity — say that assumption out loud in an interview rather than letting it hide.

Seven moving parts in the numerator, and candidates reliably produce four:

Combined net incomes — the easy part.
After-tax synergies, phased — the $pS(1-t)$ term. Interviewers ask about phasing because synergies rarely arrive at 100% in year one, and using run-rate synergies in a year-one EPS bridge overstates accretion and understates breakeven.
After-tax incremental D&A from the step-up — the one most people miss entirely. See below.
After-tax interest on new debt — the cost of debt financing.
After-tax foregone interest on cash used — cash spent stops earning, and that is a real EPS cost even in an all-cash deal that carries no new debt.
Financing fee amortization — the $F$ term, if the question gives it to you.

The step-up is the adjustment that separates candidates

In purchase accounting you write the target's assets up to fair value. That raises the depreciable and amortizable base, and the incremental D&A is a real charge against pro-forma earnings even though no additional cash leaves the business.

Worked: acquirer earns $1,000 on 1,000 shares, so $1.00 EPS. Target earns $200. All-stock, 150 new shares. The deal creates $300 of newly identified intangibles amortized over 10 years, so $30 per year of incremental amortization. Tax rate 25%. Pre-tax synergies of $40.

Numerator: $1{,}000 + 200 + 40(0.75) - 30(0.75) = 1{,}000 + 200 + 30 - 22.5 =$ $1,207.5. Shares: 1,150. Pro-forma EPS = $1{,}207.5 / 1{,}150 =$ $1.05, so accretive by about 5%.

Now delete the synergies. Numerator becomes $1{,}200 - 22.5 =$ $1,177.5, EPS = $1.024, still accretive but barely half as much. Now make the step-up $1,000 over 10 years instead, so $100 of amortization: numerator is $1{,}200 - 75 =$ $1,125, EPS = $0.978 — the deal has flipped dilutive on purchase accounting alone.

Key insight

That flip is the whole reason this adjustment gets tested. The P/E rule of thumb said this deal was accretive and the rule was right about the earnings arithmetic in isolation. A large write-up of depreciable assets can overwhelm it. Note that goodwill itself is not amortized by public filers under US GAAP, it is tested for impairment instead, so only the identified intangibles and tangible write-ups drive this. (Private companies may elect to amortize goodwill; the interview answer is the public-company one.) Candidates who know that distinction answer a question most don't.

One nuance if you get pushed: whether the step-up is deductible for tax depends on deal structure, since a stock purchase generally carries over the target's tax basis while an asset purchase steps it up. That does not change the EPS arithmetic above, because purchase accounting books a deferred tax liability for the book-versus-tax difference and it unwinds through the tax line as the intangible amortizes, leaving the same $(1-t)$ effect. What it changes is the cash tax benefit, which is exactly why buyers pay up for asset treatment.

Solving it backwards: breakeven questions

Rather than asking you to run the build, a good interviewer asks you to invert it.

Breakeven synergies. What pre-tax synergy number makes the deal EPS-neutral? Set pro-forma EPS equal to standalone EPS and solve. Using the $1,000 step-up case: we need a numerator of $1.00 \times 1{,}150 =$ $1,150. We have $1,125 before synergies, so we need $25 after tax, which is $25 / 0.75 =$ $33.3 pre-tax. Say it as a sequence: target numerator, current numerator, gap, gross it up for tax.

Breakeven premium or exchange ratio. Same logic against the share count instead. Every extra share issued dilutes, so there is a maximum exchange ratio at which the deal stays neutral. Hold the numerator fixed, solve for the share count that keeps EPS flat, and back into the price that implies.

Common mistake

Three errors, in the order people make them. Applying the P/E rule to a cash deal — it is an all-stock heuristic, and a cash deal's outcome hinges on interest rates and earnings yields, not relative P/Es. Forgetting to tax-effect synergies and interest — pre-tax synergies flowing straight to net income will overstate accretion by the tax rate every time. Using basic rather than diluted shares in the pro-forma count, which ignores the acquirer's own options and convertibles. And the conceptual one that matters most: accretive still does not mean good. An acquirer can post accretion by overpaying for declining earnings with cheap debt.

Interview tip

Ask two clarifying questions before you compute, because they change the answer and asking signals fluency: "is there a step-up in the depreciable or intangible base, and are synergies phased or fully realized in year one?" Then walk the build in fixed order, tax-effecting out loud as you go. Bankers care far more that you named the step-up than that you nailed the last decimal.

Glossary

New to the lingo? Every term used above, in plain English.

Pro forma: A combined view of two companies as if they had already merged. Pro forma EPS is the merged company earnings per share, used to test whether a deal helps or hurts.
EPS (Earnings Per Share): A company’s profit divided by its number of shares. It is the per-share slice of earnings that each shareholder owns.
P/E ratio (Price to Earnings): A company share price divided by its earnings per share. It shows how many dollars investors pay for each dollar of profit, and lets you compare how expensive stocks are.
Synergies: The extra value two companies expect to create by combining, usually cost savings or added revenue that neither could achieve alone.
Net income: A company profit after all expenses, interest, and taxes are taken out. It is the bottom line of the income statement, also called earnings.
Purchase accounting: The rules for recording an acquisition: the target assets are marked to fair value, any extra paid becomes goodwill, and write-ups can create a deferred tax liability.
Step-up (in basis): Resetting the tax basis of acquired assets up to the price paid (fair value), which creates extra future depreciation and amortization that lowers the buyer’s cash taxes.
D&A (Depreciation and Amortization): Spreading the cost of long-lived assets over the years they are used. Depreciation is for physical assets, amortization for intangible ones. Both are non-cash expenses.
Exchange ratio: In a stock deal, how many buyer shares each target shareholder receives per target share. It sets how much of the combined company the two sides end up owning.
Diluted shares outstanding: Basic shares plus the extra shares that would be created if every in-the-money option, warrant, and similar claim were exercised. Always greater than or equal to basic shares. This is the count used for equity value and diluted EPS.
Tax shield: The tax a company saves because an expense is deductible. Depreciation, for example, lowers taxable income, so it saves cash on taxes even though it is non-cash.

Frequently asked

What adjustments does a full pro-forma EPS build include?: Combine the two net incomes, then layer in after-tax synergies, after-tax incremental D&A from the purchase accounting step-up, after-tax interest on new debt, after-tax foregone interest on cash used, and any financing fee amortization. Divide by the acquirer's shares plus new shares issued. The step-up D&A is the adjustment candidates forget most often.
What is breakeven synergies?: The level of pre-tax synergies that makes pro-forma EPS exactly equal the acquirer's standalone EPS. You solve for the synergy number that closes the gap rather than testing values by trial. It is a favourite interview question because it tests whether you can rearrange the build rather than just run it forwards.
When does the P/E rule of thumb break down?: It assumes an all-stock deal with no synergies, no purchase accounting step-up, and no financing cost. Add meaningful synergies and a low-P/E buyer can still be accretive. Add a large step-up in depreciable assets and a high-P/E buyer can be dilutive. The rule is a first-order screen, not a conclusion.
Why does the step-up create dilution?: In purchase accounting you write acquired assets up to fair value, which raises the depreciable and amortizable base. That incremental D&A is a real charge against pro-forma earnings, so it reduces EPS even though no extra cash leaves the business. Goodwill itself is not amortized, but identified intangibles are.

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