Question
In: Finance
Tax effects of acquisition Connors Shoe Company is contemplating the acquisition of Salinas Boots, a firm...
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.
Solutions
Expert Solution
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.
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