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Hello Steve, the below is part of model answer(B).
If the benefits of the taxation and employee costs saved are taken into account, the value created for the shareholders is $5,609 million (see Appendix 4), and therefore significant. This would make the acquisition much more financially beneficial. It should be noted that no details are provided on the additional pre-acquisition and post-acquisition costs or on any synergy benefits that Cigno Co may derive in addition to the cost savings discussed. These should be determined and incorporated into the calculations.
Basing corporate value on the price-earnings (PE) method for the sell-off, and on the free cash flow valuation method for the absorbed business, is theoretically sound. The PE method estimates the value of the company based on its earnings and on competitor performance. With the free cash flow method, the cost of capital takes account of the risk the investors want to be compensated for and the non-committed cash flows are the funds which the business can afford to return to the investors, as long as they are estimated accurately.
Q) I am not sure about what they(below) indicate.
the additional pre-acquisition and post-acquisition costs
any synergy benefits that Cigno Co may derive
the non-committed cash flows(I have never heard the term)Thank you very much.
Who is Steve? We have nobody working for us called Steve 🙂
For the three items you list:
In the valuation we have taken into account the saving mentioned in the question, but we do not know of any other costs there may be (either before or after the acquisition). If there are more costs then obviously this stands to effect the valuation.
As regards synergy benefits, then the question does say that they will benefit from (for example) reducing the duplication of R&D work. However there may be other synergistic benefits that we are not aware of.
Non-commited cash flows refers to cash payments that they are not committed to pay i.e. the spare cash (which can then be paid out as dividends, provided (as the answer states) the spare cash can be estimated accurately).
Thanks John, I studied while listening to a song by Stevie Wonder. I got mixed up. Thank you for your clean explanation !!!
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