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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

Two large, publicly owned firms are contemplating a merger. No operating synergy is expected. However, because returns on the two firms are not perfectly positively correlated, the standard deviation of earnings would be reduced for the combined corporation. One group of consultants argues that this risk reduction is sufficient grounds for the merger. Another group thinks that this type of risk reduction is irrelevant because stockholders can hold the stock of both companies and thus gain the risk-reduction benefits without all the hassles and expenses of the merger. Whose position is correct? Explain.

Summary Introduction

To discuss: The correct position on the argument made by the group of consultants.

Introduction:

A process or an agreement where two or more firms combines together to form one new company is termed as Mergers.

Explanation

The correct position on the argument made by the group of consultants is as follows:

One group of consultant argued that the conglomerate mergers, which produce no synergy are not economically efficient. It is because two reasons which are as follows:

  • The overhead costs are incurred at the time of managing the combined corporation. As a result, the earnings will be lower.
  • The risk is not reduced since the combined corporation’s beta is a weighted average of the betas of the merged company...

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