How To Build A Merger Model

The key steps to building a merger model

How to build a Merger Model

A merger model is the analysis of the combination of two companies that come together through the M&A process. A merger is the “combination” of two companies, under a mutual agreement to form a consolidated entity. An acquisition occurs when one company proposes to offer cash or its shares to acquire another company. In all cases, both companies merge to form one company, subject to the approval of the shareholders of both companies. Below are the steps of how to build a merger model.


merger model example


#1 Making Acquisition Assumptions

The first step of a how to build a merger model is to create operating forecast for both companies and determine the feasible range for the proposed purchase price. The acquiring company can offer cash, stock or a combination of both as consideration for the purchase price.

Where the buyer’s stock is undervalued, the buyer may decide to use cash instead of equity since they would be forced to give up a significant number of shares to the target company.

In contrast, the target company may want to receive equity because it might feel more valuable than cash. Finding an agreeable consideration to both parties is a crucial part of striking a deal.

Key assumptions include:

  • Purchase price of the target
  • # of new shares to be issued to the target (as consideration)
  • Value of cash to be paid to the target (as consideration)
  • Synergies from the combination of the two businesses (cost savings)
  • Timing for those synergies to be realized
  • Integration costs
  • Adjustments to the financials (mostly accounting related)
  • Forecast / financial projects for target and acquirer

To learn more, launch our online financial modeling courses now!


#2 Making Projections

An important step in building the merger model is determining the Goodwill resulting from the acquisition of assets of the target company. Goodwill arises when the buyer acquires the target for a price that is greater than the Book Value of Net Tangible Assets on the seller’s balance sheet. Where the value of the acquired entity becomes lower than what the acquirer paid, an impairment charge will arise. As a result, the Goodwill asset will be decreased by a value equal to the impairment charge.


how to build a merger model forecast


To learn more, launch our online financial modeling courses now!


#3 Valuation of Each Business

Step 3 of how to build a merger model is a DCF analysis of each business. Once the forecast is complete it’s time to perform a valuation of each business.  The valuation will be a discounted cash flow (DCF) model that is also based on comparable company analysis and precedent transactions.  There will be many assumptions involved in this step, and it’s probably the most subjective.

The steps in performing the valuation include:


merger model valuation


To learn more, launch our online financial modeling courses now!


#4 Combination and Adjustments

Where company A acquires company B, the balance sheet items of company B will be added to the balance sheet of company A. Combining the two company’s financials will need adjustments that must be accounted for. Some of these adjustments may comprise the value of goodwill, the number of shares,  cash equivalents, etc. This section is also where various types of synergies come into play.

Key assumptions include:

  • The form of consideration (cash or shares)
  • Purchase Price Allocation (PPA)
  • Goodwill calculation
  • Any changes in accounting practices between the companies
  • Synergies calculation

Read more: Merger Factors and Complexity


#5 Deal Accretion/ Dilution

The purpose of accretion/dilution analysis is to determine the effect of the target’s financial performance on the buyer’s Pro Forma Earnings per Share (EPS). A transaction is deemed accretive if the buyer’s expected EPS increases after acquiring the target company. Conversely, a transaction is viewed as dilutive if the buyer’s EPS declines after the merger. The buyer should estimate the effect of the target’s financial performance on the company’s EPS before closing a deal.

Key assumptions include:

  • # of new shares issued
  • Earnings acquired from the target
  • Impact of synergies


merger accretion dilution


As you see in the example above, the deal is dilutive for the acquirer, meaning their Earnings Per Share is lower as a result of doing the transaction than their Earnings Per Share were before the deal.  That means, on this basis alone, the acquirer should not buy the target.

Read more: accretion dilution analysis.


Learn more about M&A

Financial Modeling Courses

Learn how to build a financial model in Excel with CFI's Financial Modeling Courses! Build a model from scratch the easy way with step-by-step instruction.

Become a certified Financial Modeling and Valuation Analyst (FMVA)™ by completing CFI’s online financial modeling classes!