Discussion
The following are dubious reasons for mergers:
(I) to diversify
(II) increasing the earnings per share (EPS)
(III) lower financing costs
(IV) industry consolidation
Answer: D
Correct answer: I, II, and III only
Diversification is dubious because shareholders can do it themselves more cheaply. Increasing earnings per share by the bootstrap effect creates no value and the market discounts it. Lower financing costs are largely an illusion - the combined firm borrows more cheaply chiefly because each set of bondholders now has a claim on both firms’ assets, which transfers value from shareholders to bondholders rather than creating it. Industry consolidation is a sound motive.
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