Pre-acquisition standalone values:

ABB = $55m

BBA = $25m

Total pre-deal value = $80m.

After the acquisition, ABB (the combined business) is expected to generate post-tax cash flows of $10m per year in perpetuity. Cost of equity = 10%, and the firm is all-equity financed, so:

Post-acquisition value=100.10=$100m\text{Post-acquisition value} = \frac{10}{0.10} = \$100\text{m}Post-acquisition value=0.1010​=$100m

Synergy value = value of combined firm − sum of standalone values:

Synergy=100−80=$20m\text{Synergy} = 100 - 80 = \$20\text{m}Synergy=100−80=$20m

So the best estimate of the synergy from the acquisition is $20 million.

Interest rate parity (IRP) says the forward exchange rate adjusts so that investors earn the same return in different currencies once hedged, otherwise arbitrage profits would exist. If parity doesn’t hold, traders can lock in risk-free gains, and their trades push rates back to parity.

So the model works well because:

Answer: C – Any divergence from parity can be observed by the market and corrected by arbitrage.

STU’s value is mainly in its people (human capital) and has few tangible assets. Net asset valuation relies on balance sheet assets, but internally generated intangibles like human capital are not recognised under normal accounting rules. So the accounts understate the real value of the business.

Answer: B. STU does not account for its intangible assets.

Profit before tax = $10m (the “10 0” in the text).

Tax @ 20% ⇒ earnings after tax = 10 × (1 − 0.20) = $8m.

For a takeover, it’s appropriate to use the takeover P/E range in the same industry: 11–12 times.

Value range = 8 × 11 to 8 × 12 = $88m to $96m.

Answer: B – Minimum $88m, maximum $96m.

A – B$ debt as a natural hedge: Borrowing in B$ to finance the B$ investment creates a natural hedge: B$ operating cash inflows help service B$ interest and principal. This reduces the net exposure of A$ shareholders to movements in the B$/A$ rate and so lowers economic risk.

D – Diversifying export markets: Selling into a variety of international markets spreads exposure across multiple economies and currencies, reducing dependence on any single one. This diversification reduces economic risk.

The other options are not true:

B: Forwards hedge specific transactions, not long-term economic risk.

C: Higher local inflation usually comes with currency depreciation and cost increases; economic risk cannot be ignored.

E: If A$ is expected to strengthen, that actually increases economic exposure to B$ earnings, it doesn’t remove it.

The seller will mainly care about:

Protecting the rest of the group – whether the sale would damage the remaining divisions.

Receiving an acceptable price – whether the MBO team can actually finance the deal.

Evaluate each option:

A: Confidential information about other divisions – If the team leaves and runs an independent business, they could use that confidential information against the remaining divisions. This clearly influences the parent’s decision. ✅

B: Skills/experience important to other divisions – If these managers are key to the success of other divisions, the parent may not want to lose them. This also directly affects the decision. ✅

C: Ability to raise finance at a reasonable price – If the team cannot raise sufficient funds, or can only do so on terms that depress the price, the parent might not proceed. This is crucial to whether the sale can happen. ✅

D: Ability to manage the divested division successfully – this matters more to the venture capitalist than to the selling company once the division is sold.

E: Conditions imposed by the venture capitalist – primarily a concern for the management team and VC, unless they somehow affect the sale price or parent’s risk, which is not indicated here.

Correct answer: A, B and C.

Regulations likely to hurt ZZZ most:

A. Minimum staff-to-client ratio – raises operating costs, particularly for a large operator.

B. Maximum price controls – directly restrict ZZZ’s ability to charge premium prices.

C. Monopoly controls forcing disposals – may force ZZZ to sell homes and shrink.

D is a one-off hit, and E is less of a threat to a high-quality provider.

Step 1 – Work out the current P/E of Company A

From the table:

Share price A = $5.00

EPS A = $0.40

P/EA=PriceEPS=5.000.40=12.5\text{P/E}_A = \frac{\text{Price}}{\text{EPS}} = \frac{5.00}{0.40} = 12.5P/EA​=EPSPrice​=0.405.00​=12.5

So A trades on a P/E of 12.5.

Step 2 – Calculate A’s and B’s current earnings

A’s shares = 20m → Earnings A = 0.40 × 20m = $8m

B’s shares = 14m → Earnings B = 0.50 × 14m = $7m

Current equity value of A (check):

8m×12.5=100m(matches 5×20)8m \times 12.5 = 100m \quad (\text{matches } 5 \times 20)8m×12.5=100m(matches 5×20)

Step 3 – Revalue B using A’s P/E after acquisition

Company A believes that after acquisition, the combined group will be seen as having the same P/E as A (12.5).

So the value of B’s earnings inside the merged group is:

Value of B in merged group=7m×12.5=87.5m\text{Value of B in merged group} = 7m \times 12.5 = 87.5mValue of B in merged group=7m×12.5=87.5m

Step 4 – Value of A after paying for B in cash

To get the post-acquisition value to A’s shareholders, take:

Post-acquisition value=Current value of A⏟100m+Value of B in merged group⏟87.5m−Cash paid for B⏟65m\text{Post-acquisition value} = \underbrace{\text{Current value of A}}_{100m} + \underbrace{\text{Value of B in merged group}}_{87.5m} - \underbrace{\text{Cash paid for B}}_{65m}Post-acquisition value=100mCurrent value of A​​+87.5mValue of B in merged group​​−65mCash paid for B​​ =100+87.5−65=122.5 million= 100 + 87.5 - 65 = 122.5\ \text{million}=100+87.5−65=122.5 million

So Company A expects the value of the merged entity (i.e. A after acquiring B for cash) to be:

$122.5 million\boxed{\$122.5\ \text{million}}$122.5 million​

Correct option: A. $122.5 million

The directors are using free cash flows to all investors but they want to value equity only. For equity valuation they should discount equity cash flows (dividends or FCFE) at the cost of equity (10%), so using WACC is a weakness → A.

The cash flow in Year 3 is stated as “Year 3 and each year thereafter = 7”. That means a level cash flow from Year 3 onwards, i.e. a perpetuity, but they have only discounted one year of it (7 × 0.794). They should have used a perpetuity factor → C.

Discounting free cash flow to all investors at WACC gives the value of the whole entity (firm value), not the equity. To get equity value you would then subtract the market value of debt. They have not done this → D.

B and E are therefore not appropriate criticisms.