These earnings are assumed to fall within the annual

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Unformatted text preview: large operating tax losses over the past few years. As a result of the acquisition, Connors believes that the total pretax profits of the merger will not change from their present level for 15 years. The tax loss carryforward of Salinas is $800,000, and Connors projects that annual earnings before taxes will be $280,000 per year for each of the next 15 years. These earnings are assumed to fall within the annual limit legally allowed for application of the tax loss carryforward resulting from the proposed merger (see footnote 4 on page 715). The firm is in the 40% tax bracket. a. If Connors does not make the acquisition, what will be the company’s tax liability and earnings after taxes each year over the next 15 years? b. If the acquisition is made, what will be the company’s tax liability and earnings after taxes each year over the next 15 years? c. If Salinas can be acquired for $350,000 in cash, should Connors make the acquisition, judging on the basis of tax considerations? (Ignore present value.) LG1 LG3 17–2 Tax effects of acquisition Trapani Tool Company is evaluating the acquisition of Sussman Casting. Sussman has a tax loss carryforward of $1.8 million. Trapani can purchase Sussman for $2.1 million. It can sell the assets for $1.6 million—their book value. Trapani expects earnings before taxes in the 5 years after the merger to be as shown in the following table. Year Earnings before taxes 1 $150,000 2 400,000 3 450,000 4 600,000 5 600,000 The expected earnings given are assumed to fall within the annual limit that is legally allowed for application of the tax loss carryforward resulting from the proposed merger (see footnote 4 on page 715). Trapani is in the 40% tax bracket. a. Calculate the firm’s tax payments and earnings after taxes for each of the next 5 years without the merger. 746 PART 6 Special Topics in Managerial Finance b. Calculate the firm’s tax payments and earnings after taxes for each of the next 5 years with the merger. c. What are the total benefits associated with the tax losses from the merger? (Ignore present value.) d. Discuss whether you would recommend the proposed merger. Support your decision with figures. LG1 LG3 17–3 Tax benefits and price Hahn Textiles has a tax loss carryforward of $800,000. Two firms are interested in acquiring Hahn for the tax loss advantage. Reilly Investment Group has expected earnings before taxes of $200,000 per year for each of the next 7 years and a cost of capital of 15%. Webster Industries has expected earnings before taxes for the next 7 years as shown in the following table. Webster Industries Year Earnings before taxes 1 $ 80,000 2 120,000 3 200,000 4 300,000 5 400,000 6 400,000 7 500,000 Both Reilly’s and Webster’s expected earnings are assumed to fall within the annual limit legally allowed for application of the tax loss carryforward resulting from the proposed merger (see footnote 4 on page 715). Webster has a cost of capital of 15%. Both firms are subject to a 40% tax rate on ordinary income. a. What is the tax advantage of the merger each year for Reilly? b. What is t...
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