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Chapter 5: Q3DQ. (page 647)

Why might the portfolio effect of a merger provide a higher valuation for the participating firms?

Short Answer

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Answer

Merger results in risk reduction for the participating companies, and also maintains the rate of return, it results in higher valuation to the participating companies.

Step by step solution

01

Step-by-Step-SolutionStep 1: Explanation on Merger

Merger is a business action taken by the top management, in which companies merge together, and continues to work in the name of existing acquiring entity.

02

Portfolio Effect

When two firms from different business cycles combine, then it results in the reduction of performance variability. Investors that are risk averse, discounts future performance at lesser rate of the participating companies, which results in assigning higher valuation to the participating companies.

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