A logistics company wants to buy a business for Rs 800 crore. Should it pay with cash, debt, new shares or a mix, given a 3.0x leverage covenant?

Recommend Rs 300 crore of cash plus Rs 500 crore of new shares: EPS rises 3.8% to Rs 10.38 and leverage stays at 2.50x. Both debt-heavy mixes take net debt to 3.54x, a covenant breach, and all-debt also dilutes EPS because debt costs 6.75% after tax against a 6.25% earnings yield on the target. At a P/E of 18, Gauravpath's shares are its cheapest currency.

Price each source in the same unit: after-tax cost per rupee. Cash costs the interest it stops earning, 6% before tax and 4.5% after; new debt costs 9% before tax and 6.75% after; new shares cost the acquirer's earnings yieldEarnings per share divided by share price, the inverse of the P/E. A P/E of 18 is an earnings yield of 5.56%., 1 over 18, or 5.56%. The target earns Rs 50 crore on Rs 800 crore, 6.25%. Any currency cheaper than 6.25% lifts EPS; any dearer cuts it. A shopkeeper who funds a new counter from savings, a bank loan or a partner faces the same three prices.

Work one fully. Cash plus shares: net income is Rs 200 crore plus Rs 50 crore, less Rs 13.5 crore of interest income given up, Rs 236.5 crore; shares rise by Rs 500 crore divided by Rs 180, 2.78 crore, to 22.78 crore. EPS is Rs 10.38, up 3.8%, and net debt is Rs 1,200 crore on Rs 480 crore of EBITDA, 2.50x. All debt is the only mix that dilutes, because Rs 54 crore of after-tax interest exceeds the Rs 50 crore the target earns.

Because the covenant is written on net debt. Spending Rs 300 crore of cash raises net debt by Rs 300 crore, exactly as borrowing it would, so the covenant cannot tell the two apart. The covenant allows net debt of at most Rs 1,440 crore on combined EBITDA, room for Rs 540 crore more. Using all of it, Rs 300 crore of cash and Rs 240 crore of debt with Rs 260 crore of shares, sits exactly at 3.0x and gives EPS of Rs 10.27, less than cash plus shares, because debt is the dearest currency here.

Say what EPS leaves out. Issuing 2.78 crore shares gives new holders 12% of the company, and if the market thinks the shares are cheap at Rs 180, issuing them transfers value to the buyers. A company with headroom also wants a buffer below the covenant, not a balance sitting on it, because EBITDA can fall. The ranking flips if the P/E is low: at 10x, shares would cost 10% and debt would become the cheaper currency, provided the covenant leaves room.