5.2·7 min read

Which Currency Is Cheaper

Cash (debt) and stock each have a cost. The cheaper financing is the more accretive one - compare the after-tax cost of debt to the buyer's earnings yield.

By the end you can

✓Compute earnings yield and after-tax cost of debt
✓Pick the more accretive currency

\text{Earnings Yield} = \frac{1}{\text{P/E}} \qquad \text{After-Tax Cost of Debt} = \text{Rate} \times (1 - \text{Tax})

The 'cost' of paying in stock is roughly the buyer's earnings yield; the cost of cash is the after-tax interest rate.

Use the cheaper currency

If the after-tax cost of debt is below the buyer's earnings yield, cash is the more currency. If the buyer's stock is expensive (low , high P/E), paying in stock is relatively cheap.

Worked example · Cash or stock?

Given

•Buyer P/E: 10.0x
•Debt rate: 5%
•Tax rate: 20%

Solution

1.Buyer
$1 / 10.0 = 10\%$
2.After-tax cost of debt
$5\% \times (1 - 0.20) = 4\%$
3.Compare
$4\% < 10\%$

Answer

Debt costs 4% after tax versus a 10% on stock, so funding with cash is more here.

Check yourself

Why is an all-cash deal often more accretive than an all-stock deal?

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The P/E Rule of Thumb

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Synergies & the Breakeven