Advanced Financial Management · Regulatory framework and processes

Payment Methods and Financing an Acquisition: Cash vs Shares

Updated 11 October 2026 · Fact-checked

The payment method decides who bears risk and who keeps control. Cash gives target shareholders certainty but may raise gearing. Shares let them share in synergies but dilute the acquirer's owners. Loan stock sits between the two. To evaluate, compute post-deal EPS, gearing, wealth gain for each side and control.

Understand Payment Methods and Financing the Acquisition

An acquirer must pay the target's shareholders with something. The main choices are cash, shares (a share exchange), loan stock (bonds or convertibles) or a mixture. Each choice shifts risk, tax, control and financing cost between the two sets of shareholders.

With a cash offer, target shareholders are paid out and leave. They take no further risk, and they take no part in the synergies. The acquirer's shareholders keep all the gain, and all the risk, if the deal works or fails. The cash must come from somewhere: existing cash, new debt or a rights issue. Debt raises gearing and interest cost. A rights issue dilutes ownership unless shareholders take up their rights. Cash is often taxable for the target shareholders straight away, which can make them demand a higher price.

With a share exchange, target shareholders become shareholders of the combined company. They share in the synergies and the risk. The acquirer's existing shareholders are diluted, so control is spread. Gearing barely changes, so the acquirer keeps debt capacity. The value of the offer moves with the acquirer's share price, so the real price paid is only known on completion. An acquirer with a high P/E ratio relative to the target often finds shares cheap to use.

Loan stock gives target shareholders fixed income and no vote. The acquirer keeps control and gets a tax shield on interest, but gearing and financial risk rise. Convertible loan stock gives a lower coupon now in return for a share of future upside. Mixed offers such as a cash alternative or a vendor placing let you balance these effects.

In the exam you judge each method from both sides. For the acquirer, check EPS, gearing, cash needs and control. For the target, check the value received, certainty, tax and ongoing stake. Then give a reasoned recommendation tied to the scenario.

Key rules to remember

Value of a share offer: Offer value per target share = exchange ratio × acquirer share price; For example, 2 acquirer shares for 3 target shares gives a ratio of 2/3. Use the acquirer's current price unless told otherwise.
New shares issued: New shares = target shares × exchange ratio; Add these to the acquirer's existing shares to get the post-deal share count.
Post-deal EPS: EPS = (acquirer earnings + target earnings + post-tax synergies − post-tax cost of new finance) ÷ post-deal shares; For cash funded by debt, deduct interest × (1 − tax rate). For cash funded by a rights issue, add the new shares.
Gearing: Gearing = debt ÷ equity, or debt ÷ (debt + equity); Use the definition the question gives. Say which one you use. Use market values if available.
Gain to each party: Target gain = value received − pre-bid market value of the target. Acquirer gain = combined value after synergies − payment value − acquirer's pre-bid value; Synergy value is shared by the method and price of the offer. Check that the gains add up to the total synergy.
Post-deal share price (P/E method): Combined value = combined post-deal earnings × P/E assumed. Share price = combined value ÷ post-deal shares; State the P/E assumption clearly. Often the acquirer's P/E is assumed to hold, though the market may re-rate it.
Cash alternative equivalence: Cash per share that matches a share offer = exchange ratio × acquirer share price; Use this to compare the two offers on a like-for-like basis.

How to solve Payment Methods and Financing the Acquisition questions

Use this order for any question on paying for an acquisition. It keeps you from missing a stakeholder or a metric.

1Read the requirement. Note which parties you must advise (acquirer, target or both) and which measures are asked for (EPS, gearing, wealth, control).
2List the offer terms for each method: cash per share, exchange ratio, loan stock terms and any mix. Convert each into a value per target share.
3Work out the financing for each method: new shares, new debt or rights issue. Include issue costs and the after-tax cost of interest.
4Compute post-deal earnings: acquirer plus target plus synergies, less finance costs after tax. Divide by post-deal shares for EPS.
5Compute gearing before and after for each method, using the definition given.
6Value the combined company and test the wealth gain for each side. Check that the shares of synergy add up.
7Assess qualitative points: control and dilution, tax for target shareholders, certainty, debt capacity, covenants, market reaction and the target's likely acceptance.
8Give a clear recommendation. Link it to the scenario and say what assumptions it depends on.

Quickest way: Three-column comparison under time pressure

When to use it: Use this when you have a short time per mark and several payment options to compare. It works well for a 20 to 25 mark question.

Draw three columns in your answer plan: cash (debt funded), share exchange and mixed.
For each column, calculate only two numbers first: post-deal EPS and gearing.
Add one line for control and one for the target's view (value, tax, risk).
Compute the wealth gain for the target under each option if the question asks about acceptability.
Write the conclusion first in your answer, then support it with the figures. State your assumptions in a line each.

Common mistakes in Payment Methods and Financing the Acquisition

Forgetting to take tax off the interest on new debt when computing EPS.
Students focus on the extra interest figure and skip the tax adjustment.
Fix: Always write interest × (1 − tax rate) as its own line. Do it before you add anything to earnings.
Valuing a share offer at the target's price or at the acquirer's old price rather than the acquirer's current price.
The exchange ratio looks like it applies to any share price.
Fix: Offer value = ratio × acquirer price. Check which price the question gives and say which you use.
Ignoring the new shares from a rights issue when the cash is raised that way.
The cash is treated as free once it is raised.
Fix: Add the new shares to the share count and deduct issue costs from the cash raised. Then compute EPS.
Recommending a method on EPS alone.
EPS is quick to calculate and looks decisive.
Fix: Add gearing, control, risk, tax for the target and the wealth gain. A method with higher EPS may carry more financial risk.
Saying a share exchange has no cost because no cash leaves the business.
Students confuse cash cost with economic cost.
Fix: Point out that target shareholders gain a share of the synergies and existing owners are diluted. That is a real cost.
Giving generic comments that do not use the scenario.
Students memorise lists of advantages and disadvantages.
Fix: Tie each point to a fact in the case: the acquirer's P/E, its current gearing, its covenants or the target's shareholders.

Worked examples

Example 1

Alpha Co has 10 million shares at $5.00 each and earnings of $6 million. Beta Co has 4 million shares at $3.00 each and earnings of $2 million. Alpha offers 1 Alpha share for every 2 Beta shares. Ignore synergies. Calculate the value of the offer per Beta share, the premium over Beta's current price, Alpha's post-deal EPS and the change in Alpha's EPS.

Show the solution

Exchange ratio is 1 ÷ 2 = 0.5 Alpha shares per Beta share.
Offer value per Beta share = 0.5 × $5.00 = $2.50.
Beta's current price is $3.00, so $2.50 is below it. The premium is (2.50 − 3.00) ÷ 3.00 = −16.7%, a discount. Beta shareholders would be unlikely to accept.
New Alpha shares = 4 million × 0.5 = 2 million. Post-deal shares = 10 + 2 = 12 million.
Post-deal earnings = $6 million + $2 million = $8 million.
Post-deal EPS = $8 million ÷ 12 million = $0.667.
Alpha's current EPS = $6 million ÷ 10 million = $0.60.
Change in EPS = (0.667 − 0.60) ÷ 0.60 = +11.1%.

Answer: The offer is worth $2.50 per Beta share, a 16.7% discount to Beta's $3.00 price. Alpha's EPS would rise from $0.60 to $0.667, up 11.1%. This is because the offer is cheap, so it is unlikely to be accepted. Alpha would need to raise the ratio.

Example 2

Gamma Co has 8 million shares, earnings of $12 million and a share price of $18. Delta Co has earnings of $3 million. Gamma will buy all of Delta's shares for $30 million in cash, raised by issuing 10% loan stock. Gamma's tax rate is 25%. Gamma has debt of $20 million and equity (market value) of $144 million. Ignore synergies. Calculate Gamma's post-deal EPS and gearing on a debt ÷ equity basis, assuming equity is unchanged.

Show the solution

Current EPS = $12 million ÷ 8 million = $1.50.
New debt = $30 million. Annual interest = 10% × $30 million = $3 million.
After-tax interest = $3 million × (1 − 0.25) = $2.25 million.
Post-deal earnings = 12 + 3 − 2.25 = $12.75 million.
Shares are unchanged at 8 million, so post-deal EPS = 12.75 ÷ 8 = $1.594.
EPS change = (1.594 − 1.50) ÷ 1.50 = +6.3%.
Gearing before = 20 ÷ 144 = 13.9%.
Gearing after = (20 + 30) ÷ 144 = 34.7%.

Answer: Post-deal EPS is $1.594, up 6.3% from $1.50. Gearing rises from 13.9% to 34.7% on a debt ÷ equity basis. EPS grows, but financial risk rises sharply. A fuller answer would note that equity value might change after the deal and that covenants and interest cover need checking.

Exam tips

Always show the offer value per target share. Markers expect it, and it lets you judge whether the target will accept.
Compute EPS and gearing for every option in a small table. Then spend your remaining time on comment, since most marks go to application.
State your assumptions, such as the P/E used, the tax rate and the gearing definition. Marks follow your stated method.
Write to the right audience. If you are advising the target board, focus on value, certainty, tax and the ongoing stake. If advising the acquirer, focus on EPS, gearing, cost and control.
Earn professional skills marks by giving a clear, justified recommendation and noting the limits of your figures, such as the risk that the acquirer's share price falls.

Practice questions from Regulatory framework and processes

Payment Methods and Financing the Acquisition in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Payment Methods and Financing the Acquisition: frequently asked questions

When is a share exchange better than a cash offer?

A share exchange suits an acquirer with a high share price or P/E relative to the target. It also suits one that is already highly geared or short of cash. Target shareholders also share in the synergies and may defer tax, which can make the offer easier to accept.

Why does cash funded by debt often raise EPS?

After-tax interest on debt is often less than the earnings the target brings, and the share count does not change. Earnings rise by more than the cost, so EPS goes up. The cost is higher gearing and financial risk, which EPS does not show.

How do I compare a cash offer and a share offer for the target's shareholders?

Convert the share offer to a value per target share using the exchange ratio and the acquirer's share price. Compare it to the cash price and to the target's current price. Then comment on risk, tax and the right to share in future gains.

What does a mixed offer achieve?

A mixed offer balances the effects of cash and shares. It limits new debt and dilution at the same time. It also lets target shareholders choose between cash now and a continuing stake, which can improve the chance of acceptance.