How do I run an accretion/dilution test for a share buyback, and when does a buyback actually increase EPS?

The accretion/dilution framework for buybacks is elegant once you see the underlying logic. The key insight is that when a company uses cash to repurchase shares, it gives up the earnings on that cash (opportunity cost) but reduces the share count.

The Rule:

A buyback is accretive to EPS if the earnings yield (E/P) of the stock exceeds the after-tax cost of financing the buyback.

• If funded with cash: Compare E/P to the after-tax return on cash
• If funded with debt: Compare E/P to the after-tax cost of debt

Worked Example:

Harborview Industries has:

• Net income: $240M
• Shares outstanding: 80M
• Current EPS: $3.00
• Share price: $40
• Earnings yield: $3.00 / $40 = 7.5%
• Cash earns 4% pre-tax, tax rate 25%, so after-tax cash yield = 3.0%

Harborview uses $200M in cash to buy back 5M shares at $40.

After Buyback:

• Lost after-tax cash income: $200M x 3.0% = $6M
• New net income: $240M - $6M = $234M
• New shares: 80M - 5M = 75M
• New EPS: $234M / 75M = $3.12

EPS rose from $3.00 to $3.12 — the buyback is accretive because the earnings yield (7.5%) exceeded the after-tax cash yield (3.0%).

Quick Decision Rule:

Exam Tip: The CFA exam may present a scenario where a company funds a buyback with debt. If the after-tax cost of debt is 4% and the earnings yield is 6%, the buyback is still accretive. Always compare E/P to the after-tax cost, not the pre-tax cost.

Practice more buyback scenarios in our CFA Level I question bank.