Economies of Scope A survey of a local market has provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15 percent. Anderson Architects (AA) has assets of $8 million and an average cost of 20 percent. Cole Home Builders (CHB) has assets of $8 million and an average cost of 17 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 must achieve economies of scope by reducing its overall average cost. To calculate the new average cost for JCC after the acquisition, we need to consider the assets and average costs of all three firms.

Total assets after the acquisition = $5 million (JCC) + $8 million (AA) + $8 million (CHB) = $21 million

Total cost savings from eliminating duplication of services = ($8 million x 20%) + ($8 million x 17%) = $2.24 million

New total cost for JCC after the acquisition = ($5 million x 15%) + ($21 million - $5 million) x (100% - $2.24 million / $21 million) / $21 million = 14.82%

Therefore, the new average cost for JCC after the acquisition should be 17.667% or lower to justify the merger.

Economies of Scope a Survey of a Local Market Has