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M&A Modeling Exam Answers | Wall Street Prep WSP
Certified Guide | Questions & Detailed Solutions
How do you calculate the pro forma EPS in an all-stock deal?
Combine Net Incomes: Add the acquirer's and target's net incomes to get the combined net
income. Calculate the New Share Count: Add the acquirer's existing shares to the new shares
issued to pay for the target. New shares issued = (Offer Price × Target Shares) ÷ Acquirer's Share
Price. Divide Combined Net Income by New Share Count: Pro forma EPS = Combined Net
Income ÷ New Total Shares Outstanding. Key Takeaway: Pro forma EPS shows the earnings per
share for the combined company after the deal, helping assess whether the deal is accretive or
dilutive.
How does the issuance of new shares in an all-stock deal impact existing shareholders of the
acquirer?
Dilution: New shares issued to pay for the target reduce existing shareholders' percentage
ownership in the combined company. EPS Impact: If the deal is accretive (pro forma EPS >
acquirer's standalone EPS), the dilution is offset by higher earnings per share, which benefits
shareholders. If the deal is dilutive (pro forma EPS < acquirer's standalone EPS), shareholders
may see a negative impact. Value Creation: The actual impact depends on whether the deal
creates enough synergies or strategic value to outweigh the dilution. Key Takeaway: Issuing new
shares dilutes existing shareholders, but the overall impact depends on whether the deal increases
or decreases shareholder value through EPS changes and synergies.
Why might an all-stock deal still be pursued even if it is dilutive in the short term?
Long-Term Strategic Benefits: The deal might offer significant synergies, such as cost savings or
revenue growth, that create value over time, offsetting the initial dilution. Preserving Cash:
Using stock instead of cash allows the acquirer to preserve liquidity for other investments or
operational needs. Shared Risk: In an all-stock deal, both parties share the risks and rewards of
the combined entity, aligning interests between the acquirer and the target. Market Conditions: If
the acquirer's stock is highly valued, issuing shares may be a less costly way to fund the deal
compared to taking on expensive debt or using cash. Key Takeaway: Even with short-term EPS
dilution, an all-stock deal can make sense if it delivers long-term value, preserves cash, and
strategically benefits both companies.
How does the deal structure (e.g., stock-only, cash-only, or mixed) affect accretion/dilution?
The deal structure significantly affects accretion/dilution. In a stock-only deal, the acquirer issues
new shares to the target's shareholders, which dilutes the acquirer's existing shareholders. If the
combined company's EPS increases due to synergies or higher earnings, the deal can be
accretive. In a cash-only deal, the acquirer uses its own cash to pay for the target, which does not
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dilute its shareholders, but it may reduce the acquirer's cash reserves or increase debt, potentially
affecting future earnings and the ability to invest. Mixed deals, combining both stock and cash,
balance the benefits and drawbacks of both structures. Stock dilution is partially offset by cash's
immediate impact, but the overall effect on accretion/dilution depends on how the mix influences
the acquirer's EPS and the cost of the transaction. Generally, cash deals are less likely to be
dilutive but might impact liquidity, while stock deals carry more dilution risk but can be more
flexible financially.
Why might a company with a lower P/E ratio want to avoid an all-stock deal?
Relative Valuation Impact: In an all-stock deal, shares are issued based on the acquirer's P/E
ratio. If the acquirer has a lower P/E than the target, it effectively values the target's earnings at a
higher multiple, leading to dilution. EPS Dilution: The deal reduces the acquirer's pro forma EPS
because the target's earnings do not fully offset the increase in shares issued. This can negatively
impact shareholder value in the short term. Perception of Overpayment: Shareholders may
perceive that the company is overpaying for the target due to the unfavorable valuation
exchange, especially if synergies are uncertain. Key Takeaway: A lower P/E acquirer risks EPS
dilution and negative shareholder perception in an all-stock deal unless the strategic benefits or
synergies clearly outweigh the dilution.
A company with a P/E ratio of 15 acquires another company with a P/E ratio of 10 in an all-stock
deal. Is the deal accretive or dilutive, and why?
Why It's Accretive: The acquirer is effectively paying less for each dollar of the target's earnings
than its own valuation. This means the target's earnings contribute more to the combined
company's EPS than the cost of issuing new shares. Key Insight: When the acquirer's P/E is
higher than the target's, the deal is typically accretive, assuming no other factors like synergies or
costs disrupt the calculation. Key Takeaway: The deal increases EPS for the acquirer's
shareholders because the target's earnings are more "valuable" relative to the acquirer's own
valuation.
Calculate the pro forma EPS if an acquirer with EPS of $5 and 10 million shares acquires a
company with EPS of $3 and 5 million shares in an all-stock deal. The exchange ratio is 1.2.
Step 1: Calculate New Share Count The acquirer issues new shares based on the exchange ratio:
New Shares Issued = Target Shares × Exchange Ratio New Shares Issued=Target
Shares×Exchange Ratio New Shares Issued = 5 𝑀 × 1.2 = 6 𝑀 New Shares Issued=5M×1.2=6M
Total shares outstanding after the deal: New Total Shares = Acquirer Shares + New Shares Issued
New Total Shares=Acquirer Shares+New Shares Issued New Total Shares = 10 𝑀 + 6 𝑀 = 16 𝑀
New Total Shares=10M+6M=16M Step 2: Combine Net Income Acquirer's Net Income:
Acquirer Net Income = Acquirer EPS × Acquirer Shares Acquirer Net Income=Acquirer
EPS×Acquirer Shares Acquirer Net Income = 5 × 10 𝑀 = 50 𝑀 Acquirer Net
Income=5×10M=50M Target's Net Income: Target Net Income = Target EPS × Target Shares
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Target Net Income=Target EPS×Target Shares Target Net Income = 3 × 5 𝑀 = 15 𝑀 Target Net
Income=3×5M=15M Combined Net Income: Combined Net Income = 50 𝑀 + 15 𝑀 = 65 𝑀
Combined Net Income=50M+15M=65M Step 3: Calculate Pro Forma EPS Pro Forma EPS =
Combined Net Income ÷ New Total Shares: Pro Forma EPS = 65 𝑀 16 𝑀 = 4.06 Pro Forma
EPS= 16M 65M =4.06
An acquirer with net income of $100 million and 20 million shares outstanding purchases a
target with $20 million in net income in an all-stock deal, issuing 5 million new shares. Is the
deal accretive or dilutive?
Step 1: Calculate Acquirer's Standalone EPS EPS = Net Income ÷ Shares Outstanding
Standalone EPS = 100 𝑀 20 𝑀 = 5.00 Standalone EPS= 20M 100M =5.00 Step 2: Calculate Pro
Forma Net Income Combined Net Income = Acquirer's Net Income + Target's Net Income Pro
Forma Net Income = 100 𝑀 + 20 𝑀 = 120 𝑀 Pro Forma Net Income=100M+20M=120M Step 3:
Calculate Pro Forma Shares Outstanding Total Shares = Acquirer's Shares + New Shares Issued
Pro Forma Shares = 20 𝑀 + 5 𝑀 = 25 𝑀 Pro Forma Shares=20M+5M=25M Step 4: Calculate
Pro Forma EPS Pro Forma EPS = Pro Forma Net Income ÷ Pro Forma Shares Pro Forma EPS =
120 𝑀 25 𝑀 = 4.80 Pro Forma EPS= 25M 120M =4.80 Step 5: Compare EPS Acquirer's
Standalone EPS = 5.00 Pro Forma EPS = 4.80
How do changes in interest rates impact accretion/dilution in a stock and debt-financed deal?
Debt-Financed Deal: Higher Interest Rates: Increase the cost of debt, reducing net income due to
higher interest expenses. This makes the deal more likely to be dilutive. Lower Interest Rates:
Reduce the cost of debt, preserving net income and making the deal more likely to be accretive.
Stock-Financed Deal: Interest rates indirectly affect the stock market. Higher Interest Rates: May
lower stock valuations, increasing dilution because more shares are needed to fund the deal.
Lower Interest Rates: Boost stock valuations, reducing the number of shares issued and making
the deal more likely to be accretive. Key Takeaway: Higher interest rates increase dilution risk
for debt-financed deals and may also increase dilution for stock-financed deals if they depress
stock prices.
How do one-time transaction costs influence accretion/dilution calculations?
One time costs temporarily reduce the combined net income in the first year of the deal. Costs
like legal fees, advisory fees, and integration expenses can dilute earnings in the short term.
A company with a share price of $40 and P/E ratio of 20 acquires another company with a share
price of $30 and P/E ratio of 10 in an all-stock deal. Determine whether the deal is accretive or
dilutive.
The deal is accretive because the acquirors 20x P/E ratio is higher than the targets 10x P/E ratio.
In an all-stock transaction, the acquirer issues shares at a higher valuation to purchase the targets
earnings at a lower multiple.
M&A Modeling Exam Answers | Wall Street Prep WSP
Certified Guide | Questions & Detailed Solutions
How do you calculate the pro forma EPS in an all-stock deal?
Combine Net Incomes: Add the acquirer's and target's net incomes to get the combined net
income. Calculate the New Share Count: Add the acquirer's existing shares to the new shares
issued to pay for the target. New shares issued = (Offer Price × Target Shares) ÷ Acquirer's Share
Price. Divide Combined Net Income by New Share Count: Pro forma EPS = Combined Net
Income ÷ New Total Shares Outstanding. Key Takeaway: Pro forma EPS shows the earnings per
share for the combined company after the deal, helping assess whether the deal is accretive or
dilutive.
How does the issuance of new shares in an all-stock deal impact existing shareholders of the
acquirer?
Dilution: New shares issued to pay for the target reduce existing shareholders' percentage
ownership in the combined company. EPS Impact: If the deal is accretive (pro forma EPS >
acquirer's standalone EPS), the dilution is offset by higher earnings per share, which benefits
shareholders. If the deal is dilutive (pro forma EPS < acquirer's standalone EPS), shareholders
may see a negative impact. Value Creation: The actual impact depends on whether the deal
creates enough synergies or strategic value to outweigh the dilution. Key Takeaway: Issuing new
shares dilutes existing shareholders, but the overall impact depends on whether the deal increases
or decreases shareholder value through EPS changes and synergies.
Why might an all-stock deal still be pursued even if it is dilutive in the short term?
Long-Term Strategic Benefits: The deal might offer significant synergies, such as cost savings or
revenue growth, that create value over time, offsetting the initial dilution. Preserving Cash:
Using stock instead of cash allows the acquirer to preserve liquidity for other investments or
operational needs. Shared Risk: In an all-stock deal, both parties share the risks and rewards of
the combined entity, aligning interests between the acquirer and the target. Market Conditions: If
the acquirer's stock is highly valued, issuing shares may be a less costly way to fund the deal
compared to taking on expensive debt or using cash. Key Takeaway: Even with short-term EPS
dilution, an all-stock deal can make sense if it delivers long-term value, preserves cash, and
strategically benefits both companies.
How does the deal structure (e.g., stock-only, cash-only, or mixed) affect accretion/dilution?
The deal structure significantly affects accretion/dilution. In a stock-only deal, the acquirer issues
new shares to the target's shareholders, which dilutes the acquirer's existing shareholders. If the
combined company's EPS increases due to synergies or higher earnings, the deal can be
accretive. In a cash-only deal, the acquirer uses its own cash to pay for the target, which does not
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dilute its shareholders, but it may reduce the acquirer's cash reserves or increase debt, potentially
affecting future earnings and the ability to invest. Mixed deals, combining both stock and cash,
balance the benefits and drawbacks of both structures. Stock dilution is partially offset by cash's
immediate impact, but the overall effect on accretion/dilution depends on how the mix influences
the acquirer's EPS and the cost of the transaction. Generally, cash deals are less likely to be
dilutive but might impact liquidity, while stock deals carry more dilution risk but can be more
flexible financially.
Why might a company with a lower P/E ratio want to avoid an all-stock deal?
Relative Valuation Impact: In an all-stock deal, shares are issued based on the acquirer's P/E
ratio. If the acquirer has a lower P/E than the target, it effectively values the target's earnings at a
higher multiple, leading to dilution. EPS Dilution: The deal reduces the acquirer's pro forma EPS
because the target's earnings do not fully offset the increase in shares issued. This can negatively
impact shareholder value in the short term. Perception of Overpayment: Shareholders may
perceive that the company is overpaying for the target due to the unfavorable valuation
exchange, especially if synergies are uncertain. Key Takeaway: A lower P/E acquirer risks EPS
dilution and negative shareholder perception in an all-stock deal unless the strategic benefits or
synergies clearly outweigh the dilution.
A company with a P/E ratio of 15 acquires another company with a P/E ratio of 10 in an all-stock
deal. Is the deal accretive or dilutive, and why?
Why It's Accretive: The acquirer is effectively paying less for each dollar of the target's earnings
than its own valuation. This means the target's earnings contribute more to the combined
company's EPS than the cost of issuing new shares. Key Insight: When the acquirer's P/E is
higher than the target's, the deal is typically accretive, assuming no other factors like synergies or
costs disrupt the calculation. Key Takeaway: The deal increases EPS for the acquirer's
shareholders because the target's earnings are more "valuable" relative to the acquirer's own
valuation.
Calculate the pro forma EPS if an acquirer with EPS of $5 and 10 million shares acquires a
company with EPS of $3 and 5 million shares in an all-stock deal. The exchange ratio is 1.2.
Step 1: Calculate New Share Count The acquirer issues new shares based on the exchange ratio:
New Shares Issued = Target Shares × Exchange Ratio New Shares Issued=Target
Shares×Exchange Ratio New Shares Issued = 5 𝑀 × 1.2 = 6 𝑀 New Shares Issued=5M×1.2=6M
Total shares outstanding after the deal: New Total Shares = Acquirer Shares + New Shares Issued
New Total Shares=Acquirer Shares+New Shares Issued New Total Shares = 10 𝑀 + 6 𝑀 = 16 𝑀
New Total Shares=10M+6M=16M Step 2: Combine Net Income Acquirer's Net Income:
Acquirer Net Income = Acquirer EPS × Acquirer Shares Acquirer Net Income=Acquirer
EPS×Acquirer Shares Acquirer Net Income = 5 × 10 𝑀 = 50 𝑀 Acquirer Net
Income=5×10M=50M Target's Net Income: Target Net Income = Target EPS × Target Shares
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Target Net Income=Target EPS×Target Shares Target Net Income = 3 × 5 𝑀 = 15 𝑀 Target Net
Income=3×5M=15M Combined Net Income: Combined Net Income = 50 𝑀 + 15 𝑀 = 65 𝑀
Combined Net Income=50M+15M=65M Step 3: Calculate Pro Forma EPS Pro Forma EPS =
Combined Net Income ÷ New Total Shares: Pro Forma EPS = 65 𝑀 16 𝑀 = 4.06 Pro Forma
EPS= 16M 65M =4.06
An acquirer with net income of $100 million and 20 million shares outstanding purchases a
target with $20 million in net income in an all-stock deal, issuing 5 million new shares. Is the
deal accretive or dilutive?
Step 1: Calculate Acquirer's Standalone EPS EPS = Net Income ÷ Shares Outstanding
Standalone EPS = 100 𝑀 20 𝑀 = 5.00 Standalone EPS= 20M 100M =5.00 Step 2: Calculate Pro
Forma Net Income Combined Net Income = Acquirer's Net Income + Target's Net Income Pro
Forma Net Income = 100 𝑀 + 20 𝑀 = 120 𝑀 Pro Forma Net Income=100M+20M=120M Step 3:
Calculate Pro Forma Shares Outstanding Total Shares = Acquirer's Shares + New Shares Issued
Pro Forma Shares = 20 𝑀 + 5 𝑀 = 25 𝑀 Pro Forma Shares=20M+5M=25M Step 4: Calculate
Pro Forma EPS Pro Forma EPS = Pro Forma Net Income ÷ Pro Forma Shares Pro Forma EPS =
120 𝑀 25 𝑀 = 4.80 Pro Forma EPS= 25M 120M =4.80 Step 5: Compare EPS Acquirer's
Standalone EPS = 5.00 Pro Forma EPS = 4.80
How do changes in interest rates impact accretion/dilution in a stock and debt-financed deal?
Debt-Financed Deal: Higher Interest Rates: Increase the cost of debt, reducing net income due to
higher interest expenses. This makes the deal more likely to be dilutive. Lower Interest Rates:
Reduce the cost of debt, preserving net income and making the deal more likely to be accretive.
Stock-Financed Deal: Interest rates indirectly affect the stock market. Higher Interest Rates: May
lower stock valuations, increasing dilution because more shares are needed to fund the deal.
Lower Interest Rates: Boost stock valuations, reducing the number of shares issued and making
the deal more likely to be accretive. Key Takeaway: Higher interest rates increase dilution risk
for debt-financed deals and may also increase dilution for stock-financed deals if they depress
stock prices.
How do one-time transaction costs influence accretion/dilution calculations?
One time costs temporarily reduce the combined net income in the first year of the deal. Costs
like legal fees, advisory fees, and integration expenses can dilute earnings in the short term.
A company with a share price of $40 and P/E ratio of 20 acquires another company with a share
price of $30 and P/E ratio of 10 in an all-stock deal. Determine whether the deal is accretive or
dilutive.
The deal is accretive because the acquirors 20x P/E ratio is higher than the targets 10x P/E ratio.
In an all-stock transaction, the acquirer issues shares at a higher valuation to purchase the targets
earnings at a lower multiple.
