M&A Interview Questions: Accretion/Dilution and Beyond

The core mechanic: accretion vs. dilution

A deal is accretive when the acquirer's pro-forma EPS rises and dilutive when it falls. The driver is a comparison of yields: if the after-tax cost of the acquisition financing is lower than the target's earnings yield (target net income ÷ purchase equity value), the deal is accretive; if higher, dilutive.

• All-cash deal: compare the after-tax interest rate on cash/debt used against the target's earnings yield. Cheap debt buying a reasonably-priced target is usually accretive.
• All-stock deal: compare the acquirer's P/E to the target's (deal-adjusted) P/E. Buying a lower-P/E target with higher-P/E stock is accretive — you are exchanging expensive earnings for cheap ones.
• Mixed consideration: weight the costs of each financing component and compare the blended cost to the target's earnings yield.

The follow-ups that test understanding

• "Why might an accretive deal still be a bad deal?" — accretion is an accounting outcome, not value creation. Overpaying with cheap debt can be accretive and still destroy value; the question is price vs. intrinsic value, not EPS arithmetic.
• "What are synergies and how do they affect the analysis?" — cost synergies (headcount, facilities, procurement) add to combined earnings and are modelled with more confidence than revenue synergies, which are routinely discounted or excluded by sceptical buyers.
• "Walk me through what happens to the balance sheet in an acquisition" — the target's assets and liabilities are written to fair value, the excess of purchase price over identifiable net assets becomes goodwill, and new intangibles may be created and amortised (with EPS impact).
• "Cash vs. stock — how does the seller think about it?" — cash is certain but taxable on receipt; stock defers tax and keeps upside/downside exposure to the combined company. Sellers weigh certainty against participation.

The traps most candidates fall into

• Forgetting the AFTER-TAX cost of debt in the accretion comparison — interest is tax-deductible, and using the pre-tax rate flips borderline answers.
• Forgetting foregone interest on cash used in the deal — cash sitting on the balance sheet was earning something; spending it has a cost even without new borrowing.
• Treating goodwill as amortising — under current US GAAP and IFRS, goodwill is tested for impairment, not amortised (a rule change candidates trained on old materials still miss).
• Answering the P/E rule for stock deals without being able to explain WHY it works (the earnings-yield exchange logic above) — the rule is memorisable, the why is the test.

How to practise

Drill the yield comparison with round numbers until it is instant: financing cost 4% after tax vs target earnings yield 6% → accretive, and by roughly the spread times relative size. Then practise narrating a full pro-forma EPS build — new shares, new interest, synergies, amortisation — in under two minutes.