2.1.2 Methods of Growth — Practice Questions

Six original multiple-choice questions on how firms grow: organic and inorganic growth, mergers and takeovers, and horizontal, vertical and conglomerate integration.

6 questions Edexcel B A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 2.1.2 Methods of Growth revision notes.

1. 1. A video-game publisher buys 60% of the shares in a rival publisher, which gives it control of the rival's board. The rival's directors had urged its shareholders to reject the offer. This is best described as

   Definition in context

   Select one answer

   A A horizontal merger.

   B A horizontal takeover.

   C A vertical merger.

   D A vertical takeover.
   Show model answer

   Answer: B (A horizontal takeover.). Two tests. What do the firms do? Both are games publishers, at the same stage of the same industry, so this is horizontal.
   How did they join? One firm bought more than half the other's shares and so controls it. That is a takeover. A merger is when two firms agree to combine, and here the rival's directors opposed the deal.

   Why the other options are wrong

   • A — The firms are at the same stage, so horizontal is right. But a merger is an agreement to combine, and this deal went ahead over the rival's objections by buying a controlling stake.
   • C — Both parts are wrong. Vertical integration joins firms at different stages of one supply chain, and the deal was a takeover, not an agreed merger.
   • D — It is a takeover, but not a vertical one. A publisher buying another publisher stays at the same stage of production.

2. 2. A firm that makes ice cream and sells it to shops buys a chain of seaside kiosks, which sell its ice cream to the public. Both businesses sell ice cream. The type of integration, and the main gain it is designed to bring, is

   Applied reasoning

   Select one answer

   A Backward vertical, securing its supply of ingredients.

   B Conglomerate, spreading its risk across unrelated markets.

   C Forward vertical, giving it a guaranteed place to sell.

   D Horizontal, giving it more power over rival makers.
   Show model answer

   Answer: C (Forward vertical, giving it a guaranteed place to sell.). Name the type from what the two firms do, not from what they both sell. The ice-cream maker produces; the kiosks are its outlets, a later stage of the same supply chain, closer to the consumer. Buying a customer or outlet is forward vertical integration.
   Its main gain is a guaranteed place to sell, with control over how its ice cream reaches the public, and it keeps the margin the kiosks used to make.

   Why the other options are wrong

   • A — Backward vertical integration means buying a supplier, such as a dairy. The kiosks are customers, so the integration runs forward.
   • B — Conglomerate integration joins firms in unrelated markets. Making ice cream and selling it are two stages of the same supply chain.
   • D — This is the trap in "both sell ice cream". Horizontal integration joins two firms at the same stage, and a manufacturer and a retailer are at different stages.

3. 3. Four firms are each choosing between growing organically and taking over a rival. Table 1 shows how much finance each could raise, the price of buying a suitable rival, and how fast its market is growing.
   Using Table 1, the firm for which a takeover is most clearly the better route is

   Data interpretation

   Table 1: Finance available, takeover price and market growth for four firms

   	Finance it could raise	Price of a suitable rival	Growth of its market each year
   Firm 1	£9m	£20m	2%
   Firm 2	£18m	£20m	26%
   Firm 3	£4m	£25m	30%
   Firm 4	£35m	£25m	28%

   Select one answer

   A Firm 1.

   B Firm 2.

   C Firm 3.

   D Firm 4.
   Show model answer

   Answer: D (Firm 4.). A takeover's advantage is speed: customers, staff and brands arrive at once. It is worth its high price and risk when two things hold:
   • the firm can pay for it: it can raise more than the price of the rival;
   • the market is moving fast, so growing slowly would hand it to rivals.
   Firm 4 can raise £35m against a £25m price, and its market grows 28% a year. It meets both, and it is the only firm that can pay for a takeover at all.

   Why the other options are wrong

   • A — In a market growing only 2% a year, buying a rival can look like the only way to grow. But Firm 1 can raise just £9m towards a £20m price, so a takeover is not open to it.
   • B — Firm 2's market is growing fast and its finance comes close, but £18m does not buy a rival priced at £20m. Close is not enough.
   • C — Firm 3's market is growing fast, but it can raise only £4m towards a £25m price. With modest finance it has no choice but to grow organically.

4. 4. A maker of kitchen appliances buys the factory that supplies all its electric motors. Two years later, an overseas producer starts selling motors of the same quality for 20% less than the factory's cost of making them. The drawback of the deal that this exposes is that the appliance maker

   Applied reasoning

   Select one answer

   A Faces more competition from other appliance makers.

   B Has lost control over the quality of its motors.

   C Is now running a business in an unrelated market.

   D Is tied to motors that cost more than rivals pay.
   Show model answer

   Answer: D (Is tied to motors that cost more than rivals pay.). Buying the motor factory is backward vertical integration: it secures supply and gives control over quality and cost. The price is lost flexibility. Now that cheaper motors are on offer, a firm that buys from outside can simply switch. This one is tied to its own factory, so it either keeps paying more for motors than its rivals do or leaves idle a factory it bought to supply them.

   Why the other options are wrong

   • A — Buying a supplier does not change how many firms make appliances. More competition would come from rivals entering, not from this deal.
   • B — This is the reverse of what vertical integration does. Owning the factory gives the firm more control over the quality of its motors, not less.
   • C — Motors are part of the appliance maker's own supply chain, so this is vertical, not conglomerate, integration.

5. 5. A firm that runs holiday parks can afford one takeover. It is choosing between another holiday-park operator and a firm that makes school uniforms. Compared with buying the holiday-park operator, buying the uniform maker is most likely to bring

   Applied reasoning

   Select one answer

   A More stable profits and smaller cost savings.

   B More stable profits and larger cost savings.

   C Less stable profits and smaller cost savings.

   D Less stable profits and larger cost savings.
   Show model answer

   Answer: A (More stable profits and smaller cost savings.). Buying the uniform maker is conglomerate integration, joining a firm in an unrelated market.
   Profits: a bad summer for holidays no longer hits the whole business, because uniform sales do not depend on it → more stable profits. Buying another holiday-park operator would double the firm's exposure to the same market.
   Cost savings: holiday parks and uniforms share almost nothing, so there are few costs to combine. Buying another park operator (horizontal) offers far more: shared booking, marketing and buying → smaller cost savings from the uniform deal.

   Why the other options are wrong

   • B — Profits are right, savings are not. Two holiday-park firms can share booking, marketing and purchasing; a holiday-park firm and a uniform maker have almost nothing to share.
   • C — Savings are right, profits are not. Spreading the business across two unrelated markets makes profit steadier, not less stable.
   • D — This describes the other deal. Buying a second holiday-park operator brings the larger savings and the less stable profits.

6. 6. A firm borrows £8 million at an interest rate of 5% a year to take over a rival. The rival makes a profit of £600,000 a year. Nothing else about either business changes. The takeover changes the firm's yearly profit by

   Calculation

   Select one answer

   A −£400,000

   B +£200,000

   C +£600,000

   D +£1,000,000
   Show model answer

   Answer: B (+£200,000). Inorganic growth is often paid for with borrowed money, and the interest is a cost.
   Yearly interest: £8,000,000 × 5% = £400,000.
   Profit gained from the rival: £600,000.
   Change in yearly profit: £600,000 − £400,000 = +£200,000.
   The deal still adds to profit, but by a third of what the rival earns, because two-thirds of it goes on interest.

   Why the other options are wrong

   • A — This counts the interest and leaves out the £600,000 profit the firm now owns. The deal brings in that profit as well as the interest bill.
   • C — This adds the rival's profit but forgets the interest on the £8 million loan used to buy it.
   • D — The interest has been added instead of subtracted. £400,000 a year paid to the lender is a cost, so it comes off the £600,000.