01 / Learn the method
Learning outcomes
Separate earnings accretion, financing effects and value creation. Calculate the result, reconcile it and communicate its limitations.
Method
A transaction can improve steady-state EPS while destroying value if its price exceeds the value of the acquired cash flows and achievable synergies. Evaluate financing, first-year integration cost and the premium separately. Here a simplified perpetual after-tax synergy value is supplied as a teaching convention, not a complete transaction model.
Smaller worked example
A buyer earning $200 on 100 shares has EPS $2. If it issues 20 shares and combined earnings rise only to $220, EPS becomes $1.83 despite higher total earnings.
02 / Put it to work
Business context and rules
Fictional Cedar Holdings buying Pine Services, at 30 September 2026. USD thousands except EPS and share price; shares are thousands. Buyer net income 400 and shares 100. Target net income 90; purchase EV 1,000 plus eligible target cash 200 less debt 400 gives equity consideration. Finance half of equity consideration with new buyer debt at 8% and half by issuing shares at $20. Target net income already reflects its existing debt costs; that debt remains in place. Annual pretax cost synergies 60, fully realized from year one; first-year pretax integration expense and cash cost 100. Tax 30% applies to synergies, integration and new buyer interest; assume deductions usable immediately. Standalone target EV 900; value synergy as a level perpetuity at 10%. No fees, purchase-accounting adjustments or other changes. Test 50% synergy realization as downside.
Original synthetic inputs
| Input | Value | Unit |
|---|---|---|
| Buyer net income | 400 | USD thousands |
| Buyer shares | 100 | thousand shares |
| Target net income | 90 | USD thousands |
| Purchase EV | 1000 | USD thousands |
| Eligible target cash | 200 | USD thousands |
| Target debt staying in place | 400 | USD thousands |
| Debt funding share | 0.5 | fraction |
| New debt interest rate | 0.08 | fraction |
| New share issue price | 20 | USD / share |
| Annual pretax synergies | 60 | USD thousands |
| First-year integration cost | 100 | USD thousands |
| Tax rate | 0.3 | fraction |
| Standalone target EV | 900 | USD thousands |
| Synergy discount rate | 0.1 | fraction |
Required deliverables
Deliver an equity and funding bridge, first-year and steady-state EPS, synergy value / downside, and an investment memo. State which omitted transaction features could materially change the recommendation.
Use formulas for derived amounts and preserve source data. Put narrative deliverables in the workbook response area; expand it as needed. Compare amounts within 0.01 of the stated unit and percentages within 0.1 percentage point. No unsupported balancing plugs.
Workbook structure
The student workbook intentionally leaves the analysis structure open. Build the schedules required above, retain the source inputs, and add formula-based checks. You may add worksheets. The worked solution is one acceptable structure, not the only correct layout.
Use an explicit downside synergy-realisation input of 50%. Change that input to test other realisation assumptions; do not embed the fraction in the value formula.
03 / Review your work
Try the assignment before opening the answer.
Open the worked answer and notes
Worked numerical schedule
| Measure | Value | Unit |
|---|---|---|
| Equity consideration | 800.00 | USD thousands |
| New buyer acquisition debt | 400.00 | USD thousands |
| New shares issued | 20.00 | thousand shares |
| After-tax new interest | 22.40 | USD thousands |
| Buyer standalone EPS | 4.00 | USD / share |
| First-year combined net income | 439.60 | USD thousands |
| First-year EPS | 3.66 | USD / share |
| Steady-state EPS | 4.25 | USD / share |
| EV premium over standalone | 100.00 | USD thousands |
| Simplified net value created | 250.00 | USD thousands |
| Net value at half synergies | 40.00 | USD thousands |
| Funding reconciliation | 0.00 | USD thousands |
Interpretation and recommended actions
Equity consideration is 800, funded by 400 debt and 20 thousand new shares. First-year income 439.6 gives EPS 3.6633 versus 4.00 standalone; steady-state EPS is 4.2467. Simplified net value is 250, falling to 40 at half synergies. This does not justify unconditional approval: validate timing and persistence of savings, integration execution, actual financing terms and purchase accounting. First-year EPS dilution does not by itself establish value destruction.
Scoring rubric - 100 points
| Dimension | Points | Awarding guidance |
|---|---|---|
| Calculation | 40 | Consideration / funding 10; EPS 15; base and downside value 15. |
| Interpretation | 25 | Correct application of the case rules 10; explain the business decision 10; identify evidence or limitations 5. |
| Controls / audit trail | 20 | Traceable formulas 8; independent reconciliation 8; explicit units and signs 4. |
| Communication | 15 | Decision and numerical headline 5; actions with owners and evidence 5; concise response covering all required deliverables 5. |
Award method credit after an isolated arithmetic error rather than repeatedly deducting for it. Equivalent account labels and well-supported alternative recommendations are acceptable. Numerical tolerance is 0.01 in the stated units; no universal passing score is prescribed.
Common mistakes
Funding enterprise value while calling it equity consideration; removing target interest twice; equating EPS accretion with value creation.
Staged hints
Bridge EV to equity first. Finance that consideration. Keep after-tax synergy value separate from EPS.
Instructor notes
Prerequisites: IBA-01/02 and transaction mechanics. The total duration of 120 minutes is a planning estimate, not a tested completion time. Allocate class time according to prior knowledge and reserve time for discussion of the decision and evidence.
For a simpler class, provide the model structure and work through one driver. For an extension, change one operational assumption and require a new reconciliation and recommendation. Verify the new key before distributing any variant. Open files in the intended spreadsheet application before class. Solutions are learning resources, not secure hiring examinations.
Decision
Make any investment recommendation conditional on credible synergies, integration delivery and financing terms.
Evidence and reasoning
First-year EPS dilution and value creation answer different questions. Integration cost affects timing, whereas synergy persistence drives the simplified value calculation. The half-synergy result leaves little room for omitted deal costs.
What would change the conclusion
Slower synergy capture, revised financing, purchase accounting or higher integration costs can reverse the recommendation. Test the explicit synergy-realisation input rather than embedding a fraction in a formula.
Related learning
Version 1.1. Synthetic teaching case. Completion time is an estimate.