Walk through a merger model
What this question is really asking
This is a sequencing question. The interviewer already knows how a merger model works — they want to hear whether you can lay out the steps in the right order without getting lost, in about two minutes, at the right level of detail.
The mistake almost everyone makes is jumping straight to earnings per share. The EPS comparison is the output. Everything interesting happens in the four steps before it, and that's where the follow-ups come from.
How to structure your answer
Step 1 — Transaction assumptions. Purchase price and the implied premium to the target's unaffected share price, the consideration mix across cash, stock and debt, the interest rate on new debt, expected synergies and when they're realised, transaction and financing fees, and the expected close date.
Step 2 — Sources and uses. Uses are the equity purchase price, refinanced target debt and fees. Sources are new debt, cash on hand and stock issued. They have to tie.
Step 3 — Purchase price allocation. Write up the target's tangible and identifiable intangible assets to fair value, record a deferred tax liability on the write-ups where the step-up isn't tax deductible, and record the remainder as goodwill. Goodwill is the plug: equity purchase price less the fair value of net identifiable assets acquired.
Step 4 — Combine the income statement. Add revenues and expenses, layer in synergies, add the incremental D&A created by the asset write-ups, add interest on the new debt, subtract interest income forgone on the cash used, and tax the result at the acquirer's rate.
Step 5 — Pro forma share count. Acquirer shares plus new shares issued, calculated as the stock portion of the purchase price divided by the acquirer's share price.
Step 6 — Accretion or dilution. Pro forma EPS against the acquirer's standalone EPS. Accretive if higher, dilutive if lower.
Step 7 — Say what you'd sensitise. Purchase price, synergy level, and the cash-stock-debt mix. Mention breakeven synergies — the level at which pro forma EPS exactly matches standalone — because it's usually the more useful output. If leverage is meaningful, note that you'd check pro forma credit statistics too.
Two minutes is the target. If they want depth on purchase price allocation, they'll ask.
What the interviewer is testing
Whether you can sequence. Someone who has built one of these knows assumptions come before sources and uses, which come before allocation, which comes before the combined income statement. Someone who hasn't tends to start at EPS and work backwards.
Whether you understand purchase price allocation. It's the step most candidates rush, and it's the one that generates the follow-ups: where goodwill comes from, why write-ups create incremental D&A, and why a deferred tax liability appears.
Whether you know which tax rate applies. The acquirer's, on the combined entity.
Whether you connect it to accretion/dilution. These are the same question at different resolutions. A candidate who can move between the full build and the P/E shortcut is comfortable with the material rather than reciting it.
Level of detail. The skill being tested is partly editorial — knowing what to include in two minutes and what to leave for the follow-up.
Frequently asked
How long should the walkthrough be?
About two minutes. Name all seven steps, spend most of the time on assumptions, purchase price allocation and the combined income statement, and stop. Interviewers will ask for depth on whichever step they care about.
How is a merger model different from an LBO model?
A merger model asks whether a strategic acquirer's EPS rises or falls. An LBO model asks what return a financial sponsor earns over a holding period. Different buyers, different outputs — EPS accretion versus IRR and multiple of money.
Where does goodwill come from?
It is the residual. Take the equity purchase price, subtract the fair value of the identifiable net assets acquired after writing them up, and whatever is left is goodwill. It is not amortised for US public companies but is tested for impairment.
Why does a deferred tax liability appear?
When assets are written up for book purposes but the step-up is not deductible for tax, book depreciation exceeds tax depreciation. That timing difference is recorded as a deferred tax liability at closing and unwinds over the life of the assets.
Does the consideration mix change whether the deal is accretive?
Substantially. Cash is usually the cheapest form of consideration in EPS terms because forgone interest income is low; stock is usually the most expensive because it is priced off the acquirer's earnings yield. Changing the mix can flip the sign.
Common mistakes
Starting at EPS. The output is not the walkthrough. Begin with assumptions.
Skipping sources and uses. It's a thirty-second step that demonstrates you know the deal has to be funded, and it sets up any leverage discussion.
Getting goodwill wrong. It's the residual after allocating purchase price to identifiable assets at fair value — not simply purchase price minus book equity, though that shortcut is sometimes used loosely.
Forgetting the deferred tax liability. Where an asset write-up isn't deductible for tax, a DTL is recorded. Mentioning it distinguishes you immediately.
Using the target's tax rate. The combined entity is taxed at the acquirer's rate.
Ignoring fees. Advisory fees are generally expensed; financing fees are capitalised and amortised over the life of the debt.
Forgetting forgone interest income on cash used. Same omission as in a standalone accretion/dilution question, and just as visible.
Ending without sensitivities. Stopping at "so it's accretive by three percent" leaves out the part that shows judgment.
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