When calculating the combined pre-tax income in a merger model, what is done with foregone interest on cash?

When calculating the combined pre-tax income in a merger model, what is done with foregone interest on cash?

• A. It is added to pre-tax income
• B. It is subtracted from pre-tax income
• C. It has no effect
• D. It becomes part of revenue

Answer: (B)

Foregone interest is the opportunity cost of using cash to fund the deal instead of keeping it invested. In the combined pre-tax income calculation, this cost is treated as a deduction because you’re sacrificing the interest that cash could have earned. Subtracting it reflects the reduced earnings due to financing with cash. For example, if $100 million of cash could earn 6% in interest, foregone interest is $6 million, which lowers pre-tax income by that amount. It’s not income or revenue; it’s a financing-related cost, so it reduces pre-tax income.

Foregone interest is the opportunity cost of using cash to fund the deal instead of keeping it invested. In the combined pre-tax income calculation, this cost is treated as a deduction because you’re sacrificing the interest that cash could have earned. Subtracting it reflects the reduced earnings due to financing with cash. For example, if $100 million of cash could earn 6% in interest, foregone interest is $6 million, which lowers pre-tax income by that amount. It’s not income or revenue; it’s a financing-related cost, so it reduces pre-tax income.