Many people think that EPS dilution in a merger model means the deal is definitely off, but not necessarily so Instead what we can do is try and find out the synergies (all the synergy increase) that will get us from dilution to EPS breakeven If we then we were able to obtain synergies in access of that, brilliant! That would take us up to EPS accretion So in short we need more profit and synergies might be the way to get it First of all, we're going to assume there are no other synergy assumptions were made. So this is our one synergy assumption We're then going to take the acquirer EPS (in this case 6.53) and by comparing that to the proforma EPS which is lower We currently see that we've got an EPS shortfall of 0.43, we have EPS dilution Okay, so we need to make up that EPS shortfall of 0.43 So what I'll do, is I'll multiply that by the proforma shares 2,994.7 And that will give me my net income shortfall, 1,287.7 Fantastic! Very tempting at this point to think, "great, if my net income is short by 1,287.7, I just need synergies of 1,287.7" But no, if I manage to get some synergies, that means me profit before tax goes up and it gets taxed So in order to get my net income shortfall of 1,287, I need to have my synergies be higher than that I actually need to the synergies to be 1,717 because those synergies will be taxed So post tax synergies required, 1,287.7 but pre tax synergies necessary 1,717 Now this table is quite useful, helps you to see where all the numbers are coming from, you can go back you can understand it To help us out here Synergies to break even or prevent dilution is your acquirer EPS minus your proforma EPS Our example in year 1, that was 0.43 You then multiply that by your proforma number of shares 2,994.7 And then you divide that by one minus your target MTR (marginal tax rate). In our example that was 25% And the number that would pop out would be 1,717 Great! So I can now put that figure into my merger model as my synergies I can then try and work out if our synergies that we can actually obtain would be even higher If they are, fantastic! We're looking more towards EPS accretion that we thought Just going back to the formula at the bottom of the screen for one moment The number that will pop out of this is a positive, however you may be looking at that MAX function in the top half And thinking, what's that there for? Well if my acquirer EPS was lower than my proforma EPS i.e. we've already got EPS accretion Then the number that will pop out of this will be a negative And that will tell me that I need to reduce my synergies by a certain amount to get to break even That's not very useful in a merger model So we use the MAX function to stop us going negative and give us a zero instead