If the sources of synergy is economy of scale in COGs, which of the following st
ID: 2744784 • Letter: I
Question
If the sources of synergy is economy of scale in COGs, which of the following statements is true?
a.
Combined firms’ sales should be bigger than the sum of the two firms’ sales.
b.
Combined firms’ sales growth rate should be higher than the weighted average of the two firms’ sales growth rate.
c.
Combined firms’ COGs should be bigger than the weighted average of the two firms’ COGs.
d.
Combined firms’ profit margin should be higher than the weighted average of the two firms’ profit margin.
a.
Combined firms’ sales should be bigger than the sum of the two firms’ sales.
b.
Combined firms’ sales growth rate should be higher than the weighted average of the two firms’ sales growth rate.
c.
Combined firms’ COGs should be bigger than the weighted average of the two firms’ COGs.
d.
Combined firms’ profit margin should be higher than the weighted average of the two firms’ profit margin.
Explanation / Answer
Cost of Goods Sold
The cost of goods sold (COGS) is any direct cost related to the production of goods that are sold or the cost of inventory you acquire to sell to consumers. It does not include overhead expenses related to the general operation of the business, such as rent. Cost of goods sold is reported on a company's income statement.
COGS = Beginning Inventory + Purchases Made During the Reporting Period - Ending Inventory
a. Combined firms’ sales should be bigger than the sum of the two firms’ sales.
b.Combined firms’ sales growth rate should be higher than the weighted average of the two firms’ sales growth rate.
c.Combined firms’ COGs should be bigger than the weighted average of the two firms’ COGs.
d.Combined firms’ profit margin should be higher than the weighted average of the two firms’ profit margin.
The premise is that 2 firms merge for reducing the COGS and are looking at the impact on the bottomline
Let’s consider each choice & reason out
A)Increased Revenue can in fact increase COGS- (Inflation vs growth example). So you can’t merely assume that increased sales decreases the cost of sales unless you know the break up of direct cost of both firms. But generally speaking, yes, Higher Revenue scales down COGS
B)Sales growth rate being higher is a better choice as it means that there is greater potential to decrease direct cost as a percentage while increasing production and sales.
C)It is definitely illogical. No firm would want their COGS to increase, especially after a merger.
D) Profit Margin has a direct bearing on the cost of Goods sold. However, a positive profit margin is a mere mathematical implication that the revenues are greater than COGS.
To simplify & compare the multiple choices, I would go with B, D & A in order of logic. C is not a correct statement.
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