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ACCA Strategic Professional · Advanced Financial Management · Acquisitions and mergers versus other growth strategies

Which of the following is the most valid argument that a conglomerate acquisition motivated purely by diversification creates value for the acquirer's shareholders?

Diversification adds value only indirectly. Shareholders can eliminate unsystematic risk themselves cheaply, so a conglomerate deal benefits them only if it lowers the costs of financial distress or increases debt capacity. It cannot remove systematic risk or guarantee earnings growth.

  1. AShareholders can already diversify cheaply themselves, so it creates value only if it reduces costs of financial distress or raises debt capacityCorrect
  2. BDiversification removes systematic risk, lowering the acquirer's required return
  3. CReducing unsystematic risk always increases the share price in a perfect market
  4. DDiversification guarantees earnings growth through the combined business

Explanation

In a well-functioning capital market investors can diversify unsystematic risk at low cost, so company-level diversification adds value only through indirect effects such as lower distress costs or greater debt capacity (tax shield). Diversification cannot remove systematic risk, and it does not guarantee growth.

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