A firm may be unable to obtain funds for its own

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Unformatted text preview: ombination. Fund Raising Often, firms combine to enhance their fund-raising ability. A firm may be unable to obtain funds for its own internal expansion but able to obtain funds for external business combinations. Quite often, one firm may combine with another that 3. Certain legal constraints on growth exist—especially when the elimination of competition is expected. The various antitrust laws, which are strictly enforced by the Federal Trade Commission (FTC) and the Justice Department, prohibit business combinations that eliminate competition, particularly when the resulting enterprise would be a monopoly. CHAPTER 17 Mergers, LBOs, Divestitures, and Business Failure 715 has high liquid assets and low levels of liabilities. The acquisition of this type of “cash-rich” company immediately increases the firm’s borrowing power by decreasing its financial leverage. This should allow funds to be raised externally at lower cost. Increased Managerial Skill or Technology Occasionally, a firm will have good potential that it finds itself unable to develop fully because of deficiencies in certain areas of management or an absence of needed product or production technology. If the firm cannot hire the management or develop the technology it needs, it might combine with a compatible firm that has the needed managerial personnel or technical expertise. Of course, any merger should contribute to maximizing the owners’ wealth. Tax Considerations tax loss carryforward In a merger, the tax loss of one of the firms that can be applied against a limited amount of future income of the merged firm over 20 years or until the total tax loss has been fully recovered, whichever comes first. EXAMPLE Quite often, tax considerations are a key motive for merging. In such a case, the tax benefit generally stems from the fact that one of the firms has a tax loss carryforward. This means that the company’s tax loss can be applied against a limited amount of future income of the merged firm over 20 years or until the total tax loss has been fully recovered, whichever comes first.4 Two situations could actually exist. A company with a tax loss could acquire a profitable company to utilize the tax loss. In this case, the acquiring firm would boost the combination’s after-tax earnings by reducing the taxable income of the acquired firm. A tax loss may also be useful when a profitable firm acquires a firm that has such a loss. In either situation, however, the merger must be justified not only on the basis of the tax benefits but also on grounds consistent with the goal of owner wealth maximization. Moreover, the tax benefits described can be used only in mergers—not in the formation of holding companies—because only in the case of mergers are operating results reported on a consolidated basis. An example will clarify the use of the tax loss carryforward. Bergen Company, a wheel bearing manufacturer, has a total of $450,000 in tax loss carryforwards resulting from operating tax losses of $150,000 a year in each of the past 3 years. To use these losses and to...
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This document was uploaded on 01/19/2014.

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