How to Answer “Explain accretion/dilution in an M&A deal.” in Investment Banking Interviews
In investment banking interview prep, this is one of the most common M&A interview questions: “Explain accretion/dilution in an M&A deal.” Interviewers want you to go beyond definitions and show you understand what actually drives pro forma EPS and how to sanity-check a deal.
A strong answer gives a clean definition, then walks through the core mechanics (purchase consideration, financing mix, synergies, and the target’s earnings yield vs the acquirer’s cost of funds), and finishes with what you would check in a simple accretion/dilution model.
What Interviewers Test with This M&A Interview Question
First, they’re testing whether you can give a correct accretion dilution explanation in plain English: accretion means the acquirer’s pro forma EPS goes up; dilution means it goes down. They want the intuition, not just a formula.
Second, they’re testing whether you understand the main drivers that show up in M&A technical questions: how stock vs cash vs debt affects the share count and interest expense, how synergies and transaction costs flow through after tax, and why purchase price and target profitability matter.
Finally, they’re evaluating judgement and communication. At analyst level, you should be able to explain what you’d build in a basic model, state key assumptions (tax rate, interest rate, timing of synergies), and give one or two practical sanity checks you’d use on a live deal.
Accretion Dilution Explanation: Step-by-Step Deal Framework
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Step 1: Define accretion/dilution and set the metric (EPS, timing, pro forma)
Start with a one-sentence definition, then clarify what you’re comparing. In most interview contexts, accretion/dilution refers to Year 1 (or next-twelve-month) pro forma EPS of the combined company versus the acquirer standalone EPS.
Call out that it’s not the same as value creation: a deal can be EPS-accretive but destroy value if you overpay or take on excessive risk. Also note the timing: accretion can flip over time as synergies ramp, amortisation fades, or financing is repaid.
If you want to show structure, preview the drivers: (1) purchase consideration and financing mix, (2) incremental earnings from the target plus synergies, (3) incremental costs like interest, D&A, and transaction/financing fees (after tax), and (4) the new share count. That framing signals you can build the model.
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Step 2: Walk through the pro forma EPS build (what changes vs standalone)
Explain the mechanics like you would build them in a simple accretion/dilution tab. Pro forma net income starts with acquirer net income + target net income, then you adjust for deal effects: add after-tax synergies, subtract after-tax incremental interest expense on new debt (and remove foregone interest income if cash is used), subtract incremental D&A from purchase accounting (if relevant at a high level), and subtract one-time transaction costs (usually excluded from “run-rate” EPS but often discussed).
Then compute pro forma EPS by dividing pro forma net income by the new diluted share count. Share count increases if stock is issued; it may also increase with option/RSU treatment depending on assumptions.
A clean way to express the intuition: the deal is more likely accretive when the target’s earnings yield (Earnings / Purchase Price) plus synergies exceeds the acquirer’s cost of financing (after-tax interest for debt, or foregone return on cash, or the “cost” of issuing equity via lower E/P).
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Step 3: Link the drivers to “why” the deal is accretive or dilutive
Now interpret what drives the result—this is where many candidates stay too mechanical. In cash/debt deals, the key trade-off is: you avoid issuing shares (good for EPS), but you add interest expense (bad for EPS). Accretion improves if you can borrow cheaply, if the target has strong earnings/EBITDA relative to price, and if synergies are credible and taxed appropriately.
In stock deals, the key trade-off is: you add little or no interest expense, but you increase the denominator (share count). These deals are often accretive when the acquirer has a high valuation multiple (high P/E, “expensive stock”), so each dollar of earnings you acquire requires issuing relatively fewer “earnings” worth of shares.
Mention two common levers: (1) purchase price / premium—overpaying makes dilution more likely, and (2) synergy timing—front-loaded synergies help Year 1 EPS much more than synergies that arrive in Year 3.
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Step 4: Add analyst-level sanity checks (and what you’d ask before modelling)
Close with quick checks that show you can pressure-test assumptions. Examples: confirm whether management wants “reported” vs “adjusted” EPS (treatment of transaction costs), ensure the tax rate used for synergies and interest is consistent, and verify the financing mix aligns with leverage constraints and credit metrics.
You can also reference a high-level valuation tie-in for investment banking valuation prep: accretion/dilution is not a substitute for IRR/NPV logic. If asked, you’d pair an EPS view with valuation and leverage impacts (e.g., pro forma Net Debt/EBITDA, rating considerations).
If time allows, state what you would request in an “investment banking M&A deal explanation” setting: purchase price, % cash/stock/debt, interest rate, target net income or EBITDA (and conversion to net income), expected synergies and one-time costs, and the acquirer’s current share count and EPS.
Analyst Model Answer for M&A Accretion/Dilution
Accretion/dilution measures whether an acquisition increases or decreases the acquirer’s pro forma EPS, typically in Year 1, versus the acquirer standalone. If pro forma EPS is higher, the deal is accretive; if it’s lower, it’s dilutive.
Mechanically, you build pro forma net income by taking acquirer net income plus target net income, then adjusting for deal effects: add after-tax synergies, subtract after-tax incremental interest expense if you use new debt (and subtract foregone interest income if you use cash), and consider purchase accounting impacts like incremental D&A. Then you divide by the new share count, which increases if you issue stock.
Intuitively, a deal is more likely to be accretive when the earnings you’re buying—think of the target’s earnings yield, plus synergies—outweigh the cost of financing. In a cash or debt deal, you avoid issuing shares but take on interest expense, so low borrowing costs and strong target profitability help. In a stock deal, you avoid interest expense but increase the share count, so having a higher P/E—or “more expensive” equity—tends to make accretion easier.
As a quick sanity check, I’d focus on purchase price and synergy timing: paying a higher multiple or assuming synergies that arrive late makes dilution more likely in Year 1. And I’d add that EPS accretion isn’t the same as value creation—you still need to be comfortable you’re not overpaying and that the combined company’s leverage and Net Debt/EBITDA remain sensible.
- Open with the definition and the comparison point (pro forma EPS vs standalone).
- Explain both the mechanics (pro forma net income and share count) and the intuition (earnings yield vs cost of funds).
- Name the main adjustments interviewers expect: synergies, interest expense, foregone interest, purchase accounting D&A, one-time costs.
- Add one sentence distinguishing EPS accretion from value creation to show judgement.
- Keep assumptions high level unless asked (tax rate, interest rate, timing).
Common Pitfalls in M&A Technical Questions (Accretion/Dilution)
- Confusing accretion/dilution (EPS impact) with whether the deal is value-accretive or strategically sound.
- Listing drivers without explaining the core intuition (target earnings yield vs financing cost).
- Forgetting the denominator: stock issuance and the new diluted share count are often the deciding factor.
- Ignoring after-tax treatment of synergies and interest expense, which can flip the result.
- Mixing “one-time” transaction costs into run-rate EPS without stating whether you’re discussing reported vs adjusted EPS.
- Overcomplicating purchase accounting details; at analyst-interview level, high-level directionality is usually enough unless prompted.
Follow-Ups You’ll Hear in Investment Banking Valuation Prep
What makes a cash deal accretive vs dilutive?
It’s accretive if the target’s earnings plus after-tax synergies exceed the after-tax interest cost (and any foregone interest) from using cash/debt; overpaying or high rates push it toward dilution.
Why are stock deals often accretive when the acquirer trades at a high P/E?
A higher P/E means the acquirer can issue fewer shares to “buy” a given amount of earnings, so the share-count increase is smaller relative to the earnings added.
How do synergies affect accretion/dilution?
Synergies increase pro forma operating profit and net income (after tax); earlier and more certain synergies improve Year 1 accretion the most.
How do you treat transaction fees in an accretion/dilution analysis?
They’re typically shown as one-time costs and excluded from “run-rate” or “adjusted” EPS, but you should be explicit about whether you’re discussing reported vs adjusted accretion.
What credit or leverage metric do you check alongside EPS accretion?
Pro forma Net Debt/EBITDA (and interest coverage) to ensure the financing plan is realistic and doesn’t create unacceptable balance-sheet risk.
How to Practise Accretion/Dilution for Investment Banking Interviews
- Practise a 60–90 second version that hits: definition → pro forma EPS build → intuition (earnings yield vs cost of funds) → one sanity check.
- Use one consistent set of assumptions when you practise (tax rate, interest rate, timing of synergies) so you can state them cleanly if asked.
- Drill two variants: “all-cash/debt” and “mostly stock,” and be able to explain how the share count vs interest expense changes the answer.
- Record yourself answering three M&A technical questions back-to-back (accretion/dilution, synergies, purchase price allocation) to improve clarity under time pressure.
- Run a mock on AceTheRound and ask for feedback specifically on structure, missing adjustments, and whether your explanation stays intuitive rather than formula-heavy.
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