10. Combining Income Statements Part 2


We finally complete our combined income statement in this lesson and calculate our net income projections for the enlarged company.

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  1. Lesson Goal (00:04)

    The goal of this lesson is to complete the combined Income Statement and calculate Net Income.

  2. Calculating Lost Interest on Cash (00:17)

    There are numerous aspects of the combined Net Interest Expense in the combined Income Statement. We start by adding the Net Interest Expense from the individual Income Statements, then add various adjustments to this amount.

    An M&A transaction often uses a large amount of cash. If the deal doesn’t go ahead, this cash could be used to generate interest in a bank account. As a result, we need to account for the interest that could be earned on the cash used in the transaction. Our transaction assumptions tell us the interest rate that can be earned on cash, the amount of cash used in the deal, and the amount of excess cash used in the deal. To find the lost interest on cash, we add the cash and excess cash used in the deal, then multiply by the interest rate on cash. This amount will be constant for each year of the combined Income Statement.

  3. Calculating Interest on New Debt (01:48)

    The Net Interest Expense will be increased by the interest paid on new debt acquired for the purposes of the transaction. We calculate this expense by multiplying the amount of debt used in the deal by the interest rate on new debt. These figures can both be found in our transaction assumptions.

    At this stage of our model, we are assuming that the principal amount stays constant. If the debt is amortized or allows early repayment, this will not be the case, so this calculation will need to be updated later in the model.

  4. Calculating Interest Saved on Refinanced Debt (02:45)

    If the transaction involves refinancing the existing debt of both companies, then the Net Interest Expense will be reduced by the amount of interest that would be paid on existing debt. 

    Our model includes a switch that can be used to indicate whether existing debt is refinanced. If the debt is refinanced, then the Net Interest Expense in the combined Income Statement is reduced by the combined amount of the Net Interest Expense in the two individual Income Statements.

  5. Calculating the Amortization of Financing Fees (03:59)

    The final adjustment to the Net Interest Expense is the amortization of financing fees. This amortizes the cost of debt fees over a number of years specified in the transaction assumptions. To calculate the annual amount, we take the debt issuance fee (which is a percentage of the total amount of debt issued) and divide by the number of years in the amortization period.

    Note that this expense is not always included in a combined Income Statement, and some analysts and clients may prefer to leave it out. If in doubt, check whether your client expects this expense to be included.

  6. Calculating Net Income (05:01)

    We calculate the Net Interest Expense by adding the individual Net Interest Expenses and the various adjustments. Note that any item which increases the expense (for example the interest paid on new debt) should be a negative number, while any item that reduces the expense (for example interest saved in refinanced debt) should be a positive number.

    To calculate pre-tax income, we subtract the Net Interest Expense from EBIT. We then find the Income tax provision by multiplying the pre-tax income by the tax rate, which is found in the transaction assumptions. Finally, we calculate Net Income by subtracting the Income tax provision from the pre-tax income. This completes the combined Income Statement.


In the previous lesson, we began building our combined income statement and proceeded down as far as EBIT. In this lesson, we're going to complete the combined income statement and calculate net income. As you can see, I've automatically added the net interest expense for both the target and the acquirer. Now, we're going to account for the lost interest on cash. If this deal is completed, we'll be spending a lot of cash in getting the deal over the line. Primarily through excess cash in our sources table, which I can see if I scroll to the very top.

This $74 million could be used to generate interest in a bank account if the deal doesn't go ahead, and we need to account for this lost interest. From a look at current interest rates, which are very low, I'm going to assume that the company will only achieve a 1% interest on this cash, if it's placed in a short term deposit account. I'll enter 1% here, scroll down, and make my calculation.

So it would be minus the interest rate, multiplied by the cash in my sources and uses table, here, and of course the excess cash as well.

Now copy across for the remaining cells. But before I do that, I'll need to anchor.

Next, I have interest on new debt. Again, this is pretty easy to calculate. When I scroll up to the top, I'll find my interest rate of 5.2%, and multiply this by the amount of debt, which I can find in my sources and uses table.

As I mentioned in an earlier lesson, the debt principal will be paid down by 10% each year, and it may allow for early repayment. However, we haven't made these calculations yet, so for now, I'm going to assume that the debt principal stays at a constant value and we can update this calculation later. So I'll simply copy across, with Control + R. To remind me to update this calculation, I'll highlight this row.

Next, I have the interest saved in refinanced debt. In this scenario, I must first check if the debt is going to be refinanced. And if the debt is going to be refinanced, then this figure will be positive. Because I will no longer have to pay interest on the existing debt. If the debt is not going to be refinanced, then this will be zero. So I'll write an if function, that checks if the debt will be refinanced.

If this is equal to one, then I'll simply return the interest from the acquirer, which I can find on the income statement, and from the target.

In my formula, I'll need to anchor cell E7, and then I can copy across. And as you can see, this 3.1 nets off against the -2.6, and the -0.5 from earlier.

Lastly, we have the amortization of financing fees. This entry amortizes the cost of debt fees over a period of time. It's a new non-cash expense, so some analysts prefer to leave it out when combining the income statement. I don't think it's gonna be a very big number, so in this case, I'm going to leave it in, because I also want to show you how to calculate this figure. However, in your own models, you may choose to leave it out, particularly if the client requests so. To calculate this figure, I'll scroll up to the very top, and I'll take the debt issuance fee, anchor, and then multiply by the total amount of debt.

I'll anchor again, and then divide by the time period in question.

And there I'll copy across for the remaining cells. But first, I'll put in a minus sign.

As you may have seen, it's quite easy to make mistakes with positive and negative signs in your combined income statement. Always be sure to check, does it intuitively make sense if a number is positive, or negative, before you complete the calculation. To calculate net interest income or expense, I'll simply write the sum, and copy across.

I can now calculate my pre-tax income, by taking EBIT, and adding the net interest income or expense.

My income tax provision will simply be the pre-tax income, multiplied by the tax rate, which I have at the very top.

And again, I'll copy across.

And to calculate net income, I simply subtract one from the other.

And now my combined income statement is complete.