Arroyo, Rey Anne D.
PCBET 18-702E
A
Smitty’s Home Repair Company
A. Several reasons have been proposed to justify mergers. Among the more prominent
are (1) tax considerations, (2) risk reductions, (3) control, (4) purchase of assets at
below-replacement cost, and (5) synergy. In general, which of the reasons are
economically justifiable? Which are not? Which fit the situation at hand? Explain.
 The economic justification for mergers is synergy and tax implications. When the merged
firm's value exceeds the sum of the individual firm's values, it is said to be synergistic. A
synergistic merger generates value that must be distributed among the merging firms'
stockholders. Synergy can come from one of four places:
(1) Economies of scale in management, production, marketing, and distribution;
(2)Financial economies, which could include more debt capacity, cheaper transaction costs,
or greater securities analyst coverage, to name a few examples.
(3) Mergers that promote management efficiency, as well as increased market power as a
result of decreased competition, are socially beneficial, while mergers that reduce
competition are both undesirable and illegal. Another acceptable reason for mergers is tax
implications.
Tax losses have been accumulated and are being used to hide current and future income.
The carry-forwards may be used without the merger in the future, but their value would be
higher if they were used now rather than later. Risk minimization, asset acquisition at a
discount to replacement cost, and control are among the less economically viable
objectives, and managers frequently claim that diversification helps to stabilize the market.
A company's profits stream, which lowers overall risk and benefits shareholders.
Employees, suppliers, consumers, and management all benefit from a firm's earnings
stability. Furthermore, we know that well-diversified shareholders are more concerned with
a stock's market risk than its stand-alone risk, and that higher earnings are more important
to them.