Answer (B) is correct . Undervaluation of the firm to be acquired may result if the market focuses on short-term earnings rather than long-term prospects. Such a firm may be a bargain for the acquirer. Another aspect of undervaluation is that a firm’s q ratio (market value of the firm’s securities ÷ replacement cost of its assets) may be less than one. Hence, an acquiring firm that wishes to add capacity or diversify into new product lines may discover that a combination is less expensive than internal expansion.
Answer (A) is incorrect because If the q ratio of a firm to be acquired exceeds one, the market value of the firm’s securities exceed the replacement value of assets.
Answer (C) is incorrect because If replacement cost is less than book value, internal expansion is less expensive.
Answer (D) is incorrect because Internal expansion may be the better bargain for the acquirer.
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