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ACCA Strategic Professional · Advanced Financial Management · Corporate environmental, social, governance (ESG) and ethical issues

Orion Ltd has 10 million shares at $8.00 each, with a market-value-based agency cost estimate as follows. Shareholders believe that, under current management, an agency-cost-driven inefficiency reduces firm value by 6% of the equity value. A bidder could remove the inefficiency by a takeover costing $2.0 million in fees and other costs. Ignoring any bid premium considerations beyond this, what is the maximum net gain available to the bidder if it acquires 100% of the equity at the current price and the inefficiency is fully removed?

The maximum net gain is $2.8 million. Equity is worth $80 million, the removable inefficiency is 6% of that, or $4.8 million, and the takeover costs of $2.0 million must be deducted. The result is a $2.8 million net benefit to the bidder.

  1. A$2.8 millionCorrect
  2. B$4.8 million
  3. C$0.0 million
  4. D$6.8 million

Explanation

Equity value is 10m x $8 = $80m. The 6% inefficiency is worth $4.8m. Deducting $2.0m costs gives a net gain of $2.8m. Omitting the costs gives $4.8m; adding them gives $6.8m, which is wrong in sign.

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