Case 010Accretion and dilutionCore

A logistics company borrows to buy back shares at a premium. What happens to EPS, and at what buyback price or interest rate does it break even?

Deutsche BankSan Francisco · 2025

The situation

Korvani Logistics earns Rs 200 crore a year and has 50 crore shares, so EPS is Rs 4.00. The shares trade at Rs 60, a P/E of 15.

The board proposes borrowing Rs 300 crore at 10% before tax and using it to buy back shares through a tender at a 10% premium, Rs 66 a share. Tax is 25%, and the cash is otherwise idle.

Your task

Is the buyback accretive or dilutive to EPS, by how much, and what buyback price or interest rate would make it break even?

Quick check

Shares are bought on a P/E of 16.5 at the tender price. Is the buyback accretive?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

EPS falls about 2.4%, from Rs 4.00 to Rs 3.91. At Rs 66 the shares bought earn 6.06% on their price, while the debt costs 7.5% after tax. The buyback breaks even at a price of Rs 53.33, where the earnings yield equals 7.5%, or at a pre-tax interest rate of about 8.08% at the Rs 66 price.

Step 1What is the one comparison that decides it?

Every share bought back takes its earnings out of the denominator; every rupee borrowed takes interest out of the numerator. A debt-funded buyback raises EPS only when the earnings yieldEarnings per share divided by the share price, the inverse of the P/E. on the shares bought is higher than the after-tax cost of the debt. It is like borrowing at 7.5% to buy out a partner whose share of profit pays 6.1% on what you paid: you own more of the business and earn less.

Here the shares earn Rs 4.00 against a Rs 66 price, 6.06%. The debt costs 10% less a quarter saved in tax, 7.5%. The answer is dilutive before you compute a single share count. Notice that at the Rs 60 market price the yield is 6.67%, still short: the premium makes it worse, but it is not the only problem.

Korvani's shares bought at Rs 66 earn 6.06% on their price against a 7.5% after-tax cost of debt, so the buyback dilutes EPS; it would break even only at a buyback price of Rs 53.33, where the earnings yield reaches 7.5%.

Step 2How do the full numbers work?

Prove it. Interest is Rs 30 crore before tax, Rs 22.5 crore after. Rs 300 crore at Rs 66 buys 4.55 crore shares. Earnings fall to Rs 177.5 crore and shares to 45.45 crore, so EPS is Rs 3.905, down 2.4%.

	Before	After buyback
Net income, Rs crore	200.0	177.5
After-tax interest, Rs crore		(22.5)
Shares, crore	50.00	45.45
EPS, Rs	4.00	3.91
Net debt added, Rs crore		300

Korvani's net income falls by Rs 22.5 crore of after-tax interest while the share count falls by 4.55 crore, taking EPS from Rs 4.00 to Rs 3.91, a 2.4% dilution.

The relationship

P^{*} = \frac{\text{EPS}}{r(1-t)} = \frac{4.00}{0.10 \times 0.75} = 53.33 \qquad r^{*} = \frac{4.00/66}{0.75} = 8.08\%

P*	buyback price at which EPS is unchanged
r*	pre-tax interest rate at which EPS is unchanged at the Rs 66 price
t	tax rate, 25%

What it says in wordsThe buyback breaks even where the earnings yield on the shares equals the after-tax cost of the debt; solve for price with the rate fixed, or for the rate with the price fixed.

Step 3If EPS falls, is the buyback a bad idea?

Not necessarily, and saying so is what separates a good answer. EPS accretion is an accounting test, not a value test. Replacing equity with debt lowers the company's cost of capital up to a point through the tax shield, and a board may believe the shares are worth more than Rs 66. Against that, Korvani now carries Rs 300 crore of new debt, a year and a half of its entire net income, in a cyclical industry where freight volumes can fall sharply. Name both sides, then say the numbers alone do not justify it at this price.

Where candidates lose it

The reflex answer is that a buyback always raises EPS because the share count falls. That forgets the interest on the debt that paid for it, which can remove more earnings than the shares carried.

The second miss is using the pre-tax rate of 10% against a 6.1% yield, which exaggerates the dilution; the comparison must be after tax, 7.5%.

What the interviewer asks next

If Korvani used idle cash earning 6% instead of new debt, is the buyback accretive?
How does the answer change if the shares trade at a P/E of 10?
Why might a buyback at a premium transfer value between shareholders?

Asked at Deutsche Bank, Investment Banking, San Francisco, 2025 (Wall Street Oasis): What happens to EPS if a company issues debt to buyback shares

Company names and figures are illustrative.