So why couldn't you use conservation of PE in that problem?
What is conservation of PE? I'm not trying to be argumentative but I don't understand exactly what you mean by that. Conservation of two quantities allows us to write Q1=Q2 at two different moments, express the two in some way and solve the equation. For example, the preservation of momentum can give you m1v1+m2v2=m1v1'+m2v2' for the momentum before and after the collision. What are the two PE energies that you want to say are equal?
If you want to calculate how much PE the ball on the right has and say that it was all converted to PE when both balls go up, that would be incorrect. You can use that only when PE+KE=const, meaning there is additional energy added to/lost from the system. The inelastic collision will convert some of the KE to heat (or some other energy), for which you are not accounting.
They have the proper steps in the question:
From PE+KE=const, get the KE at the bottom.
From KE, get the speed and from that the momentum at the moment of collision.
Since momentum is preserved, it stays the same after the collision.
Get the new speed from the momentum - you already know it, since it did not change.
Get KE from the momentum.
Since KE+PE=const' (different one), you know what PE will be when KE=0.
Get the height from the new PE.