What is Accretive
Accretive is the process of accretion, which is growth or increase by gradual addition, in finance and general nomenclature. An acquisition is considered accretive if it adds to the item's value or corporation’s earnings per share. In corporate finance, accretive acquisitions of assets or businesses add more value than the cost of the acquisition, either immediately or over time.
BREAKING DOWN Accretive
In fixed-income investments, the term refers to the increase in value attributable to interest accrued but not paid; discounted bonds, for example, earn interest through accretion until maturity. Accretion, in general finance, refers to the change in the price of a bond or security. This most directly relates to situations where the bond is acquired at a discount when compared to the current face value of the bond, also known as the par. As the bond matures, the value increases based on the interest rate in effect at the time of issuance.
In corporate finance, accretion is the creation of value after a transaction has taken place. This can be due to new assets being acquired at a discount or below their perceived current market value. It can also include the acquisition of assets anticipated to grow in value due to the transaction occurring.
Determining the Rate of Accretion
The rate of accretion is determined by dividing the discount by the number of years in the term. In the case of zero coupon bonds, the interest acquired is not compounding. While the value of the bond increases based on the agreed-upon interest rate, it must be held for the agreed-upon term before it can be cashed out.
Examples of Accretion
If a person purchases a bond with a value of $1,000 for the discounted price of $750 with the understanding it will be held for 10 years, the deal is considered accretive. The bond pays out the initial investment plus interest. Depending on the type of bond purchase, interest may be paid out at regular intervals, such as annually, or in a lump sum upon maturity.
If the bond purchase is a zero coupon bond, there is no interest accrual. Instead, it is purchased at a discount, such as the initial $750 investment for a bond with a face value of $1,000. The bond pays the original face value, also known as the accreted value, of $1,000 in a lump sum upon maturity.
A primary example within corporate finance is present during the acquisition of one company by another. First, assume the earnings per share of Corporation X is listed as $100 and earnings per share of Corporation Y is listed as $50. When Corporation X acquires Corporation Y, Corporations X’s earnings per share increase to $150. This deal is 50% accretive due to the increase in value. However, sometimes, long-term debt instruments, like car loans become short-term instruments when the obligation is expected to be fully repaid within one year. If a person takes out a five-year car loan, after the fourth year, the debt becomes a short-term instrument.
For corporations, long-term debt instruments come in the form of corporate debt. This type of debt is used to fund growth and expansion and is classified on a company's balance sheet.