What is accretive?
Both in finance and in the general lexicon, the term “relutive” is the adjective form of the word “relution”, which refers to gradual or incremental growth. For example, an acquisition agreement can be considered accretive for the acquiring company, if this agreement contributes to an increase in earnings per share.
By definition, in corporate finance, accretive acquisitions of assets or businesses must ultimately add more value to a business than the expenses associated with the acquisition. This may be due to the fact that the newly acquired assets in question are purchased at a price lower than their current perceived market value, or if the assets are expected to grow, as a direct result of the transaction.
Key points to remember
– The term “accretive” is an adjective which refers to commercial transactions which result in a progressive or incremental growth in the value of a company.
– In corporate finance, acquisitions of accretive assets must add more value to a business than the acquisition costs of the target entity,
– Accretive transactions can occur if the assets acquired are purchased at a price lower than their current perceived market value.
– In general finance, accretive investments refer to any security purchased at a discount.
In general finance, the increase refers to the variation in the price of a bond or a security. In fixed income investments, the word accretive can be used to describe the increase in value attributable to accrued but unpaid interest. For example, discounted bonds earn interest through discounting until they mature. In such cases, the bonds acquired are acquired at a discount from the current face value of the bond, also known as a peer. As the bond matures, the value increases with the interest rate in effect at the time of issue.
Determine rate of increase
The discount rate is determined by dividing the discount by the number of years to come. In the case of zero coupon bonds, the interest earned is not compounded. Although the value of the bond increases with the agreed interest rate, it must be held for the agreed term before it can be redeemed.
Examples of accretion
If a person buys a bond valued at $ 1,000, at the reduced price of $ 750, it being understood that it will be held for 10 years, the transaction is considered accretive, because the bond pays the initial investment, plus interest. Depending on the type of bond purchased, interest may be paid at regular intervals (annually, semi-annually, etc.), or it may be paid in one installment, at maturity.
With zero coupon bonds, there is no accumulation of interest. Instead, it is bought at a discount, like the initial investment of $ 750 for a bond with a face value of $ 1,000. The bond pays the original face value, also known as increased value, of $ 1,000 in a lump sum at maturity.
In corporate financing, acquisition operations are often accretive. First, assume that earnings per share for company X is listed as $ 100, and earnings per share for company Y is listed as $ 50. When Company X acquires Company Y, earnings per share of Company X increases to $ 150, making it an accretive transaction of 50%.
[Important: The antonym to “accretive” is “dilutive”, which describes any deal which causes a corporation’s earnings per share value to drop.]