Which of the following best describes the two main reasons that firms purchase equity shares in other firms?

• A. To reduce tax liabilities and to increase inventory turnover
• B. To earn investment income and to exert influence or control over the investee
• C. To increase cash reserves and to avoid financial reporting
• D. To comply with government regulations and to decrease liabilities

Answer: (B)

Verified step by step guidance

1. Understand the context of the question: Firms purchase equity shares in other firms for strategic and financial reasons. This involves analyzing the motivations behind such investments.
2. Clarify the concept of 'investment income': Investment income refers to the earnings generated from investments, such as dividends or capital gains, which are a primary reason firms invest in equity shares.
3. Explain the concept of 'influence or control': When a firm purchases a significant portion of another firm's equity, it may gain the ability to influence decisions or exert control over the investee, which can be strategic for business operations.
4. Evaluate the incorrect options: For example, reducing tax liabilities, increasing inventory turnover, or avoiding financial reporting are not primary reasons for purchasing equity shares. These options do not align with the strategic and financial goals of firms.
5. Conclude by identifying the correct answer: The two main reasons firms purchase equity shares in other firms are to earn investment income and to exert influence or control over the investee. This aligns with the strategic and financial objectives of such investments.