Case 026Accretion and dilutionHard

A pharma company buys a diagnostics firm with a mix of its own cash, new debt and new shares. Find the EPS change and the pre-tax synergies needed to break even.

EvercoreMenlo Park · 2025

The situation

Brahvi Pharma earns Rs 600 crore a year on 40 crore shares, so EPS is Rs 15.00, and the shares trade at Rs 225, a P/E of 15. It agrees to buy Nivrit Diagnostics, a chain of pathology labs earning Rs 90 crore, for Rs 1,500 crore.

The price is funded three ways: Rs 300 crore of Brahvi's own cash, which earns 6% before tax in deposits; Rs 500 crore of new debt at 9%; and Rs 700 crore of new Brahvi shares issued at Rs 225. Tax is 25% for both companies and there are no synergies in the base case.

Your task

Is the deal accretive or dilutive to Brahvi's EPS, by how much, and what pre-tax synergies would make it exactly neutral? Explain which part of the funding does the damage.

Quick check

Brahvi pays 16.7x earnings for Nivrit, above its own 15x. Before any maths, what does that tell you?

Worked solution

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

30-second answerThe answer to give first

The deal is slightly dilutive: EPS falls from Rs 15.00 to Rs 14.91, about 0.6%, and Rs 5.22 crore of pre-tax synergies would make it neutral. Net income rises to Rs 642.75 crore after Rs 13.5 crore of interest lost on the cash and Rs 33.75 crore on the new debt, but the share count rises to 43.11 crore. Nivrit earns 6.0% on its price while the funding costs 6.26% after tax, so the shares and the debt do the damage and the cash softens it.

Step 1What is the one test that works for any funding mix?

Compare what the target earns on the price with what the money costs. A deal is accretive when the target's earnings yield on the price paid is higher than the blended after-tax cost of the cash, debt and shares used to pay it. Each source has its own cost: cash costs the interest it was earning, debt costs its coupon, and shares cost the acquirer's own earnings yield, because each new share takes a slice of existing profit. Think of buying a second flat with some savings, a home loan and a share of your first flat given to a partner: the rent must beat what each of those three really costs you.

Nivrit earns Rs 90 crore on Rs 1,500 crore, 6.0%, a P/E of 16.7. Brahvi's cash was earning 6% before tax, 4.5% after. The new debt costs 9% before tax, 6.75% after. New shares cost Brahvi's earnings yield, Rs 15.00 over Rs 225, 6.67%. Weighted by rupees, the Rs 1,500 crore costs 6.26% after tax, so the deal is dilutive before you touch a share count. It is close because the cheap cash pulls the blend down.

What each rupee of funding costs after tax, against what Nivrit earns on itIdle cash forgone: 6% x (1 - 25%)4.50%New debt: 9% x (1 - 25%)6.75%New shares: 15.00 / 2256.67%Blended, weighted by rupees6.26%Nivrit earns on its price: 90 / 1,5006.00%6.00%: what the Rs 1,500 crore buysBlended cost 6.26% beats the 6.00% earned: the gap, Rs 3.92 crore after tax, is the Rs 5.22 crore of pre-tax synergies needed.
Nivrit earns 6.0% on the Rs 1,500 crore price, while the funding costs 4.5% on the cash, 6.75% on the debt and 6.67% on the shares, a blended 6.26% after tax, so the deal is dilutive by the small gap between the two.
Step 2How do the full numbers work?

Build the numerator, then the denominator. Brahvi's Rs 600 crore plus Nivrit's Rs 90 crore is Rs 690 crore. Cash of Rs 300 crore at 6% earned Rs 18 crore before tax, Rs 13.5 crore after, which is now gone. Debt of Rs 500 crore at 9% costs Rs 45 crore before tax, Rs 33.75 crore after. Pro forma net income is Rs 642.75 crore. Rs 700 crore at Rs 225 is 3.11 crore new shares, so 43.11 crore in all, and EPS is Rs 14.91, down 0.6%. Earnings rise 7.1% and shares rise 7.8%; that is the whole story in one line.

Rs croreBrahvi alonePro forma
Brahvi net income600.00600.00
Nivrit net income90.00
Interest lost on Rs 300 crore of cash, after tax(13.50)
Interest on Rs 500 crore of new debt, after tax(33.75)
Net income600.00642.75
Shares, crore40.0043.11
EPS, Rs15.0014.91
Brahvi's net income rises by Rs 42.75 crore while its share count rises by 3.11 crore, so EPS slips from Rs 15.00 to Rs 14.91, a dilution of 0.6%.
Brahvi's earnings after the deal: more profit, more shares, slightly less per share, Rs crore600.0Brahvistandalone+90.0Nivrit'searnings-13.5Interest loston cash-33.75Interest onnew debt642.75Pro formaAxis starts at 550 so the small steps can be seenPer shareShares: 40.00 + 3.11= 43.11 croreEPS before: Rs 15.00EPS after: Rs 14.91-0.6%, dilutiveEarnings rise 7.1%,shares rise 7.8%
Brahvi's net income climbs from Rs 600 crore to Rs 642.75 crore once Nivrit's Rs 90 crore is added and Rs 13.5 crore of lost deposit interest and Rs 33.75 crore of new interest are taken off, but spread over 43.11 crore shares that is Rs 14.91 a share, below the Rs 15.00 before the deal.
Step 3What synergies would make it neutral, and how do you get there fast?

Work from the gap, not from scratch. To keep EPS at Rs 15.00 on 43.11 crore shares, net income must be Rs 646.67 crore. The shortfall is Rs 3.92 crore after tax, which is Rs 5.22 crore of pre-tax synergies. The same number falls out of the yield test: the blended cost exceeds the yield by 0.26 points of Rs 1,500 crore, Rs 3.92 crore. Against Nivrit's Rs 120 crore of pre-tax profit, that is a saving of about 4%, which shared lab procurement and one finance team could plausibly deliver; say that, and say that promised synergies arrive late and cost money to capture.

The relationship
S∗=EPS0×Npf−NIpf1−t=15.00×43.11−642.750.75≈5.22S^{*} = \frac{\text{EPS}_0 \times N_{pf} - \text{NI}_{pf}}{1 - t} = \frac{15.00 \times 43.11 - 642.75}{0.75} \approx 5.22
S*pre-tax synergies at which EPS is unchanged, Rs crore
N_pfpro forma share count, 43.11 crore
NI_pfpro forma net income before synergies, Rs 642.75 crore
ttax rate, 25%
What it says in wordsBreakeven synergies are the after-tax earnings needed to lift pro forma net income back to the old EPS on the new share count, grossed up for tax.
Step 4Which part of the funding does the damage?

Rank the three sources by cost and the answer writes itself. Cash at 4.5% is the only source cheaper than Nivrit's 6.0% yield; shares at 6.67% and debt at 6.75% both cost more than the target earns. So the mix Brahvi chose is already the least dilutive one available: all shares would give EPS of Rs 14.79, and all debt Rs 14.72, both worse. The interviewer's follow-up is usually why a company would do a dilutive deal at all. EPS is an accounting test over one year. If Nivrit's earnings grow faster than Brahvi's, or the labs give Brahvi a channel for its own tests, the deal can be dilutive in year one and right in year three. Say the test, say its limit.

Where candidates lose it

The common loss is applying the P/E rule, 16.7x paid against 15x own, and declaring the deal dilutive by a large margin. That rule holds only for all-stock deals; with Rs 800 crore of cash and debt in the mix the real gap is six-tenths of a per cent, and a candidate who says 'badly dilutive' has shown they do not know why the rule works.

The second miss is forgetting the interest Brahvi stops earning on its own cash. Spending Rs 300 crore of deposits costs Rs 13.5 crore of after-tax profit, and leaving it out flips the sign of the answer.

What the interviewer asks next

  • If the debt were 7% instead of 9%, is the deal accretive?
  • Why is the P/E rule a special case of the earnings yield test?
  • Nivrit's earnings grow 20% a year and Brahvi's 8%. When does the deal turn accretive?
  • How would transaction fees of Rs 30 crore, funded with more debt, change the breakeven synergies?

Asked at Evercore, Investment Banking, Menlo Park, 2025 (Wall Street Oasis): interview was very technical, had a screening call roughly two weeks before my round 1. some crazy accretion/dilution math

Company names and figures are illustrative.