Merger Model Interview Questions: What to Expect

You’ll learn about the most common merger model questions in this tutorial, as well as what type of “progression” to expect and the key principles you must understand in order to answer ANY math questions on this topic.

Table of Contents:

3:26 Question #1: The Basic Rules

5:23 Question #2: With Real Numbers

8:21 Question #3: Equity Value, Enterprise Value, and Valuation Multiples

12:17 Question #4: Ranges for the Multiples

14:26 Question #5: What if the Buyer is Twice as Big?

16:26 Recap, Summary, and Key Principles

Question #1: The Basic Rules

"A company with a P / E multiple of 25x acquires another company for a purchase P / E multiple of 15x. Will the deal be accretive or dilutive?"

ANSWER: You can’t tell unless it’s a 100% Stock deal. If it is, it will be accretive because the Cost of Acquisition is 1 / 25, or 4%, and the Seller’s Yield is 1 / 15, or 6.7%. Since the Seller’s Yield is higher, it will be accretive.

For Cash and Debt deals, or deals with a mix of all three, you’d calculate the Weighted Cost of Acquisition by using Foregone Interest Rate on Cash * (1 – Buyer’s Tax Rate) * % Cash + Interest Rate on Debt * (1 – Buyer’s Tax Rate) * % Debt + 1 / (Buyer’s P / E Multiple) * % Stock and compare that to the Seller’s Yield.

Question #2: With Real Numbers

“Let’s say it is a 100% Stock deal. The Buyer has 10 shares at a share price of $25.00, and its Net Income is $10. It acquires the Seller for a Purchase Equity Value of $150. The Seller has a Net Income of $10 as well. Assume the same tax rates for both companies. How accretive is this deal?”

ANSWER: The buyer’s EPS is $10 / 10 = $1.00. It must issue 6 additional shares to do the deal, so the Combined Share Count is 10 + 6 = 16.

Since both companies have the same tax rate and since no Cash or Debt is used, Combined Net Income = $10 + $10 = $20, and Combined EPS = $20 / 16 = $1.25, so the deal is 25% accretive.

Question #3: Equity Value, Enterprise Value, and Valuation Multiples

“What are the Combined Equity Value and Enterprise Value in this same deal? Assume that Equity Value = Enterprise Value for both the Buyer and Seller.”

ANSWER: Combined Equity Value = Buyer’s Equity Value + Value of Stock Issued in the Deal = $250 + $150 = $400.

Combined Enterprise Value = Buyer’s Enterprise Value + Purchase Enterprise Value of Seller = $250 + $150 = $400.

The Combined EV / EBITDA multiple won’t be affected by the mix of Cash, Stock, and Debt, but the P / E multiple will be. It’s 20x here ($400 / $20), but it will change for non-100%-Stock deals.

Question #4: Ranges for the Multiples

“Without doing any math, what ranges would you expect for the Combined EV / EBITDA and P / E multiples, and why?”

ANSWER: They should be somewhere in between the Buyer’s multiples and the Seller’s purchase multiples. It’s almost never a simple average because of the relative sizes of the Buyer and Seller – and for P / E, the purchase method also plays a role.

Question #5: What if the Buyer is Twice as Big?

"What happens if the Buyer is twice as big, i.e. it has an Equity Value of $500 and Net Income of $20?"

ANSWER: The deal becomes *less* accretive because the company making it accretive, the Seller, now has a lower weighting. The Buyer was previously $250 / $400 of the total, but is now only $500 / $650, which is ~63% vs. ~77%, so we’d expect accretion to fall by 10-15%, which it does.

The Combined Multiples will all be closer to the Buyer’s multiples now as well.

Recap, Summary, and Key Principles

Principle #1: If the Seller’s Yield is above the Weighted Cost of Acquisition, it’s accretive; dilutive if the opposite.

Principle #2: Combined Equity Value = Buyer’s Equity Value + Value of Stock Issued in the Deal.

Principle #3: Combined Enterprise Value = Buyer’s Enterprise Value + Purchase Enterprise Value of Seller.

Principle #4: The Combined P / E Multiple is affected by the Cash / Debt / Stock mix, but the Combined EV / EBITDA Multiple is not.

Principle #5: The Combined Multiples will be in between the Buyer’s multiples and the Seller’s purchase multiples – exact numbers depend on sizes of the Buyer and Seller.

RESOURCES:

[addoumhakim]

Thank you so much for these really intuitive and detailed videos.

[laurasanders]

Brian, could you do a tutorial on how to do the quick mental math in finance? A lot of the calculations seem to be done in the head rather than carefully calculated -- could you give some tips on how to become good at that? Thanks

[altynnurzhekey]

Thank you for the great video!!! Where can we download the excel file?

[jonnycleans]

Thank you again for the grat contents! I was wondering about how does the math work in the 1st question, as I have the following point:
- if the buyer P/E > seller P/E and 100% stock is accretive, why in say 50% stock should not be? given that the less the stock consideration the more accretive is the deal, generally speaking

[Tom-kyis]

Thanks for the video! How do you calculate the maximum interest rate so that the deal does not become dillutive? (100% debt)

[steveallerdini]

Hi Brian, thanks a lot, great insights, really helpful for interviews.
I have a question on pro-forma P/E multiple. When buyer pays premium to the seller, in the absence of synergies do you take into account premium when you calculate combined Equity Value and P/E multiple?

[tedwong]

Hi Brian, thanks for a really informative video. Quick question for you in regards to Principle #4: is it fair to say that cash does not go towards equity value because that cash is not exclusive to equity holders (it would be used to pay off debt or preferred stock first)?

[muhamadkhir]

Thank you so much for this great video. I can't believe it's really detailed. I'm wondering if u can share the excel that you used in the video? Thanks

[TheVincedagreat]

Hi Brian,


Thanks for everything you're doing. You're sort of a messianic figure in the finance world. If I may ask, I have a final round M&A interview coming up at a tech company's in-house team tomorrow. Do you have any tips regarding which topics I should focus on to prepare?


Again, thank you very much for everything!

[Kevin-hkid]

It seems like whenever the deal is dilutive, the P/E ratio is no longer between the buyer and seller multiples. For example, if you try an all debt deal and increase the interest rate to 20%.

[yoelherman]

Thanks a lot for the video. Quick Question - In question 5, the deal becomes less accretive when the buyer's is getting bigger in equity size compared to the seller's equity size, but no matter how bigger the buyer's equity is, as long as the buyer's P/E is bigger than the seller's P/E, it will mean that the deal will be accretive, right?

[flaviohns]

Got an interview question about company A acquiring company B, that has just distributed dividends and how the equity post deal is affected by that. Told that the Equity Value post deal would be the equity value of company A minus dividends, this is correct, and if so why ?

[Bertztuful]

Hi Brian, great video

I recently came across a DCF for a an acquisition target in which future Growth Capex was not included in the DCF. The reason given was that this is value that the potential buyer will add . Is this a standard assumption in M&A modeling ?

Thanks

[ChristianDG]

Question what could happen if the debt of the target is higher than the cash? and I would please to clarify why cash is presented as negative? thats because need to discount from the EV?

[nishchalmittal]

Hey Brian. Great video. I can not see the link to download the excel file.

[ahmedzakikhan]

Hi. Are all these assuming there is no synergy benefit to merger ?

[alexandrete]

Dear Brian,

Thanks, great video as always!
6min 30; question 2 ; do we agree that it is almost an oversimplification to stipulate that the buyer can issue 6 shares to buy the other company, at 150$,  taking into account the initial share price of his company (25$), and no potential decrease of share price after the issue?

I mean, it seems soo "simple" not to take into account other factor / effect of the issue on the price/share, that I have some difficulties following this ; and Wonder what happens in practice in a 100% equity deal

Thx

[andrewcameron]

Great video, but one question on the EV/EBITDA multiples.
You mention that the combined EV/EBITDA multiples are unaffected by the way the deal is funded (e.g 100% cash, 100% debt or 100% stock), but wouldn't a 100% debt funded takeover leave the combined group with more debt and therefore result in a higher EV/EBITDA multiple?

[albiebaggins]

Do these sorts of things get asked if you're going into an internship? I feel like I might be going above what I need for SA internships, and in-fact doing work to level of interview for a FTime position. Any advances on that?

[dylanrocksify]

Are these questions common for internship positions?