Accretion/Dilution: The Basic Concept

Step 1: Standalone EPS and P/E

EPS = Net Income / Shares Outstanding

Acquirer EPS = $400m / 100m = $4.00; Acquirer P/E = $80.00 / $4.00 = 20.0x

Target EPS = $100m / 50m = $2.00; Target P/E = $20.00 / $2.00 = 10.0x

The P/E multiple is what the market currently pays for a dollar of each company's earnings. It matters here because, in an all-stock deal, the acquirer is effectively "paying" for the target's earnings using its own stock — and the multiple it pays relative to its own multiple is what drives accretion or dilution.

Step 2: Offer Price and Exchange Ratio

Offer Price per Target Share = Target Share Price × (1 + Premium)

Using the target's $20.00 share price and the 20% (0.20) premium:

Offer Price = $20.00 × 1.20 = $24.00 per Target share

Exchange Ratio = Offer Price / Acquirer Share Price = $24.00 / $80.00 = 0.300x

New Shares Issued = Exchange Ratio × Target Shares Outstanding = 0.300 × 50m = 15.0m new Acquirer shares

It's also useful to translate the offer price into an effective P/E paid: $24.00 / $2.00 Target EPS = 12.0x. This is the number that actually matters for the accretion/dilution test — not the Target's pre-deal 10.0x multiple, because the acquirer isn't paying the pre-deal price, it's paying the premium-inclusive offer price.

Step 3: Pro Forma Combined Net Income

Pro Forma Net Income = Acquirer Net Income + Target Net Income = $400m + $100m = $500m

Because this is a 100% stock deal with no synergies assumed, the two net income figures simply add together — there's no new interest expense (no debt raised) and no foregone interest income (no cash used).

Step 4: Pro Forma EPS

Pro Forma Shares Outstanding = Acquirer Shares + New Shares Issued = 100m + 15.0m = 115.0m

Pro Forma EPS = Pro Forma Net Income / Pro Forma Shares Outstanding = $500m / 115.0m = $4.35

Compared to the Acquirer's standalone EPS of $4.00, that's an increase of $0.35, or +8.7% accretion. The deal is accretive because the effective P/E paid for the Target's earnings (12.0x) is well below the Acquirer's own trading multiple (20.0x) — the Acquirer is "buying" earnings more cheaply than the market currently values its own earnings, so folding those earnings in mechanically lifts EPS.

Final Results

• Pro Forma EPS: $4.35 vs. $4.00 standalone (+8.7% accretive)
• Effective P/E Paid for Target: 12.0x vs. Acquirer's own P/E of 20.0x (break-even is 20.0x — pay any less and the deal is EPS-accretive)

This accretion/dilution result is typically the first screen bankers and boards look at when sizing up a proposed stock deal, but it's only a starting point — the next step is usually pressure-testing the synergy assumptions behind the premium paid and checking whether the deal still clears the acquirer's cost of capital on a returns basis, not just an EPS basis.

Would you like to see how this changes if part of the consideration is paid in cash instead of stock, or if cost synergies are layered in?