Question

Tax effects of acquisition Connors Shoe Company is contemplating the acquisition of Salinas Boots, a firm that has shown 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 its 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 carry forward resulting from the proposed merger. The firm is in the 21% 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.)

show work please and explanation.

Answer 1

Answer:

a) If Connors does not make the acquisition :

Particulars	Amount
Annual Earnings before taxes	$    280,000.00
Less: Tax @21%	$      58,800.00
Annual Earnings after taxes	$    221,200.00

Company tax liability is $58,800 and annual earnings after taxes is $221,200

b) If Connors make the acquisition :

Particulars	Year 1	Year 2	Year 3	Year 4-15
Annual Earnings before taxes	$    280,000.00	$    280,000.00	$    280,000.00	$ 280,000.00
Less : Tax Loss	$ (280,000.00)	$ (280,000.00)	$ (240,000.00)	$                   -
Earnings after setting off Tax Loss	$                     -	$                     -	$      40,000.00	$ 280,000.00
Less: Tax @21%	$                     -	$                     -	$        8,400.00	$    58,800.00
Annual Earnings after taxes	$                     -	$                     -	$      31,600.00	$ 221,200.00

c) Decision :

If company does not acquires, total earnings after tax will be : $221,200*15 years = $3,318,000

If company acquires, total earnings after tax will be: $31,600+$221,200*12 years = $2,686,000

If company acquires then, total saving is $3,318,000 - $2,686,000 = $632,000

Based on above, we can conclude that Salinas can be acquired for $350,000.