Investment Banking Interview Questions / Questions
Easy

Walk me through a merger model

How to answer it in an investment banking interview: what is being tested, a step-by-step framework, a sample answer and the mistakes to avoid.

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What the interviewer is testing

Whether you know the steps of an accretion/dilution analysis, the adjustments that matter, and the quick P/E rule for all-stock deals.

Answer framework

  1. Set the purchase price and form of consideration (cash, stock, debt).
  2. Project both companies' income statements.
  3. Combine and adjust: foregone interest on cash, interest on new debt, new shares issued, amortization of new intangibles, synergies.
  4. Compute pro forma EPS and compare with the buyer's standalone EPS.
  5. Mention the fuller version: pro forma balance sheet with purchase price allocation and goodwill.

Sample answer

I set the purchase price and form of consideration: cash, stock or debt. I project both companies' income statements, combine them and adjust for foregone interest on cash used, interest on new debt, new shares issued, amortization of new intangibles and synergies.

Then I compute pro forma EPS and compare it with the buyer's standalone EPS. If pro forma EPS is higher, the deal is accretive; if lower, dilutive. A fuller model also builds the pro forma balance sheet with purchase price allocation and goodwill.

Accretion/dilution is a shorthand that markets watch, but it is not the same as value creation; a dilutive deal can still create value and vice versa.

Likely follow-ups

In an all-stock deal, what determines accretion or dilution? If the buyer's P/E is higher than the P/E it pays for the target, the deal is accretive, ignoring synergies and other adjustments.
And for a mixed deal? Compare the weighted cost of acquisition (after-tax cost of debt, foregone interest on cash, buyer's earnings yield for stock) with the seller's earnings yield at the purchase price.

Common mistakes

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Related questions

Based on questions #51, #52, #53 in the full question bank.