Question

Company X currently operates in the retail industry. The company decides to acquire a company in the pharmaceutical industry and a company in the retail industry with a higher cost of capital. Discuss the value relevance of this mergers and acquisition decision.

Answer 1

Here the company has made two acquisition, one a similar retail company and another a company in the pharmaceutical industry. The reason of acquisition of pharmaceutical company can be to diversify its operation, diversifying operation does have benefit. Your revenue sources are not dependent on one source and you can use your existing brand to scale up the operation of the pharmaceuticals of the company. Another acquisition company made is in the retail industry with higher cost of capital, here the purpose of acquisition seems to be increasing market share, and getting the benefit of economies of scale. When the company acquires the higher cost of capital and merges with the existing operation, its overall cost of capital should come down while increasing the market share and revenue base for the company. The value of any merger or acquisition is derived from the fact after merging it with the existing operation it will reduce the cost of operation and increase the market share.