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the solution to the June 2012 question 1 is shown as (10,000 x 80% x 0.88/1.1) kindly help me understand the last bit of the solution. why 0.88/1.1?
Deferred consideration
On 1 April 2011, Pyramid acquired 80% of Square’s equity shares…..
…a cash payment of 88 cents per acquired share, deferred until 1 April 2012.
Pyramid’s cost of capital is 10% per annum.Square’s equity shares = 10,000
deferred consideration = $0.88 * (80%*10,000) * (1/{1+0.10}^1)
= 80% * 10,000 * 0.88/1.1
when the consideration is deferred, we need to discount it to present value. this is done by the last part of the calculation above.
the formula is 1 / [(1+r)^n]
where, r is the cost of capital
n is the number of years the consideration is deferred.in this qn, r is 10% = 0.10
n is 1 year.Hope that helps
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