We are now ready to complete the pro forma income statement for the combined business. Our goal here is to show whether or not the transaction is accretive or dilutive to the acquirer in the years subsequent to the transaction.


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In calculating accretion/dilution, we must include all transaction adjustments. The equations used to calculate the “Interest (Income) / Expense” line item for 2009 and beyond might be intimidating, but can be broken down into four components: 1) the sum of the standalone companies’ interest (income)/expenses, 2) incremental interest expense on acquisition debt, if any, used to finance the transaction, 3) any interest income lost due to the use of the companies’ cash balances to fund the acquisition, and 4) a reduction in interest expense due to conversion, if any, of TargetCo’s convertible securities (TargetCo’s convertible debt pays 2.5% interest if not converted, but pays no interest if converted to equity). We could also make adjustments here for TargetCo’s standalone contribution to the combined company’s interest expense based on whether previously outstanding debt was retired or assumed by BuyerCo. For example, if BuyerCo retires TargetCo’s $230 million convertible debt issue, there would be no post-transaction interest expense associated with the convertible debt regardless of whether or not the convert is “in-the-money”.

In calculating the pro forma interest (income)/expense, we combine several steps that we perform separately in the “After-Tax Acquisition Adjustments” section of a subsequent topic on accretion/dilution. Therefore, it may facilitate your understanding of how to compute pro forma interest (income)/expense by studying this topic first and returning to the pro forma income statement afterwards to complete the accretion/dilution.

Other adjustments are made in the “Other Transaction Adjustments” line item, including any write-down of deferred revenue and any deferred stock-based compensation expense previously calculated.

Note that we only computed accretion/dilution for cash, rather than GAAP, accounting results. You could take the pro forma P&L a step further by additionally computing GAAP accretion/dilution in a manner similar to that used to arrive at GAAP EPS on TargetCo’s and BuyerCo’s income statements.

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