Walk me through a basic merger model

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A merger model is analyzes the financial profiles of 2 companies, the purchase price and considerations, and determines whether the merger is accretive or dilutive to the buyer.

  1. The first step is to make some assumptions about the acquisition - what the purchase price is and whether it was cash, stock, debt or some combination of the three
  2. Next, you determine the valuations and shares outstanding for both companies
  3. Then, you project out the Income Statement financials for each company
  4. After that, you combine the Income Statement line items, adding up things like revenue and expenses and then adjusting for things like Foregone Interest on Cash and Interest Paid on Debt into a combined Pre-Tax Income line
  5. Finally, you apply the acquiring company's tax rate to get the combined Net Income and then divide it by the new share count to determine the combined EPS

If the combined EPS is greater than the buyer's standalone EPS, then the deal is accretive. If the combined EPS is lower than the buyer's standalone EPS, then the deal is dilutive.