Economies of Scope A survey of a local market has provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $4 million and an average cost of 10 percent. Anderson Architects (AA) has assets of $5 million and an average cost of 20 percent. Cole Home Builders (CHB) has assets of $5 million and an average cost of 15 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. What should be the average cost after the acquisition for JCC to justify this merger?

Question

Quizplus · Accepted Answer

To justify the merger, JCC needs to lower its average cost after the acquisition. Economies of scope can be achieved by eliminating the duplication of services, which reduces the average cost of the merged company.

To calculate the new average cost, we need to first calculate the total assets of the merged company:

Total assets = $4 million + $5 million + $5 million = $14 million

The new average cost can be calculated as follows:

New average cost = (JCC cost + AA cost + CHB cost) / Total assets
= (10% + 20% + 15%) / $14 million
= 45% / $14 million
= 0.03214 or 3.214%

Since JCC's current average cost is 10%, the new average cost of 3.214% represents a significant reduction in costs. Therefore, we can conclude that the merger is justified if JCC can achieve an average cost of 15.357% or lower. Choice A is the only option that meets this requirement.

Economies of Scope a Survey of a Local Market Has