Question

Consider this scenario:A firm acquires a strategically related target; there were no other bidding firms. Under what conditions, if any, can the firm that acquired this target expect to earn an economic profit from doing so?

Answer 1

The first condition is the creation of economic value added (EVA) due to the acquisitions of the target firm. It measures the wealth creation to the firm that is over and above the required cost of capital of the investment done to acquire the target. If the wealth is positive, then economic profit is created due to the acquisitions. The second conditions is the creation of economy of scope due to the acquisition of the target firm. As a part of the acquisition, now different product lines are being produced under the same overhead cost. It results into the synergy effect and average total cost of production, comes down. It causes the firm after the acquisition, to earn positive economic profit. The third condition is the resources complementing each other that creates economy of scale in the firm. It brings increasing return to scale and average total cost also comes down with the increased level of production. It makes the firm to earn revenue that is over and above the total cost. It creates positive economic profit.
Besides, the improvement in learning curve, innovation and risk management expertise as a Part of the balanced scorecard after the acquisition if achieved, also helps the firm to achieve the economic profit.