Dhatuvan Castings earns Rs 200 crore on 10 crore shares and buys Lohasar Forgings, which earns Rs 50 crore, for Rs 500 crore funded entirely with 5% debt. At a 25% tax rate, is the deal accretive or dilutive, and by how much?

Accretive by about 15.6%: EPS rises from Rs 20.00 to Rs 23.12. Interest on Rs 500 crore at 5% is Rs 25 crore, Rs 18.75 crore after tax. Combined net income is 200 plus 50 less 18.75, Rs 231.25 crore, over the same 10 crore shares. The one-line reason: Lohasar earns 10% on its price and the debt costs 3.75% after tax.

Compare the cost of the money with what it buys. A debt-funded deal is accretive whenever the target's earnings yieldNet income divided by the price paid, the inverse of the P/E. Rs 50 crore on Rs 500 crore is 10%, a P/E of 10. exceeds the after-tax cost of the debt. Lohasar earns Rs 50 crore on Rs 500 crore, 10%, a P/E of 10. The debt costs 5%, and because interest is tax-deductible the real cost is 5% times 0.75, 3.75%. A shopkeeper who borrows at 3.75% to buy a stall earning 10% is better off from the first month, and no partner has been given a share of the shop.

Prove it in three lines. Interest is 5% of Rs 500 crore, Rs 25 crore a year; after the 25% tax shield it costs Rs 18.75 crore. Combined net income is Rs 200 crore plus Rs 50 crore less Rs 18.75 crore, Rs 231.25 crore, and because the deal is all debt the share count stays at 10 crore, so EPS is Rs 23.12 against Rs 20.00, up 15.6%.

When the after-tax cost of debt equals the earnings yield. Breakeven is 10% divided by 0.75, a pre-tax rate of 13.3%; at any rate below that the deal adds to EPS. That is the follow-up interviewers like, because it tests whether you understood the shortcut or memorised the arithmetic. The second follow-up is funding: if Dhatuvan paid in shares at Rs 300 each, a P/E of 15, it would issue 1.67 crore new shares and EPS would be Rs 21.43, 7.1% accretive, less than with debt because stock at a P/E of 15 costs 6.7%, more than debt at 3.75%.

Whether the deal is a good one. Accretion measures one year of accounting earnings; it says nothing about whether Rs 500 crore was a fair price for Lohasar or whether 5% debt is safe for the combined business. Buying a target on a P/E of 10 with cheap debt is almost always accretive, which is exactly why a board should look past it: a cyclical forgings business bought at the top of its earnings can be accretive on paper and value-destroying in cash. Ask what Lohasar's earnings look like in a weak year and what leverage Dhatuvan carries after the deal, then give the EPS answer.