Assume the post tax earnings can be taken as a close proxy for cash flows. NPV is negative so project is not worthwhile The CEO feels that the company's cost of equity is too high and decides that one way of reducing the cost of equity and benefiting shareholders would be to diversify out of its core house building business. The CEO feels that being in commercial property management and the tool hire business will give the company a better balance of cash flows and make the company less risky. This should benefit shareholders. Discuss the merits of this statement.
Diversification is a bad idea.
Shareholders can usually diversify less expensively than the company can. Companies are easier to understand if they remain focused. Information about companies is harder to get at in diversified companies. On the stock market diversified companies usually trade at a discount to other companies. There is a danger that the management don't have the skills to succeed in the other markets.