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CA Final · Advanced Financial Management · Mergers, Acquisitions and Corporate Restructuring

A merger between a pharma company and an unrelated cement company, undertaken mainly to diversify earnings and reduce the combined firm's cash-flow volatility, is a conglomerate merger. Which statement about the financial synergy expected from such a merger is most appropriate?

Financial synergy in a conglomerate merger comes from lower combined risk, since unrelated cash flows are not perfectly correlated. This can increase debt capacity and reduce the cost of capital. Economies of scale, market power and supply security relate to horizontal or vertical mergers.

  1. AIt arises mainly from economies of scale in production
  2. BIt arises from lower combined risk, which can raise debt capacity and lower the cost of capitalCorrect
  3. CIt arises from eliminating a competitor and gaining market power
  4. DIt arises from securing assured raw material supply

Explanation

Unrelated businesses give little operational overlap, so synergy is financial: imperfectly correlated cash flows reduce risk, increase debt capacity and may lower cost of capital. Scale economies, market power and supply security belong to horizontal or vertical mergers.

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