Economies of Scope A survey of a local market 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 acquisition, JCC needs to achieve economies of scope, which means reducing average costs by eliminating duplication of services. To calculate the post-merger average cost, we need to add up the assets of all three firms and calculate their weighted average cost.

Total Assets = $5 million (JCC) + $8 million (AA) + $8 million (CHB) = $21 million

Weighted Average Cost = [(JCC's Assets/Total Assets) * JCC's Average Cost] + [(AA's Assets/Total Assets) * AA's Average Cost] + [(CHB's Assets/Total Assets) * CHB's Average Cost]

= [(5/21) * 0.15] + [(8/21) * 0.20] + [(8/21) * 0.17] 
= 0.0714 + 0.0952 + 0.0809 
= 0.2475 or 24.75%

Thus, to justify the merger, the post-merger average cost should be lower than the pre-merger average cost of 24.75%. The only choice that meets this criteria is A) 17.667 percent or lower.

Economies of Scope a Survey of a Local Market Provided