A+B = (A+B)

Should an Organization Diversify into Different Business Areas?

This question is crucial because one of the fundamental principles in financial theory is the principle of value additivity, which implies that 1+1=2.

[ PV(a) + PV(b) = PV(ab) ]

However, diversification clearly creates value. How do these two theories align?

The issue is that in developed markets, investors can diversify on their own. Therefore, diversification undertaken by an organization does not create practical value. Additionally, investors can diversify more easily and at lower costs than organizations can.

Therefore, it is better for management to focus on targeted and consistent growth rather than diversification.

Source:

Principles of Corporate Finance, by Richard Brealey, Stewart Myers, and Franklin Allen