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 $950,000, and Connors projects that its annual earnings before taxes will be $420,000 per year for each of the next 15 years. These eamings are assumed to fall within the annual mit legally allowed for application of the tax loss carryforward resulting from the proposed merger. The firm is in the 289 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. the acquisition is made, what will be the company's tax liability and earnings after tacos each year over the next 15 years c. If Salinas can be acquired for $269,000 in cash, should Connors make the acquisition, judging on the basis of tax considerations (Ignore the time value of money.) a. Without the acquisition, the firm's tax payment in years 1 through 15 is $ (Round to the nearest dollar)

Answer 1

Part-a:

If Connors does not make the acquisition, company’s tax liability each year over the next 15 years would be = 420,000*28% = $117,600

.

And company’s earnings after tax each year over the next 15 years would be = Earnings before tax – Tax = (420,000-117,600)

= $302,400

.

	{1}	{2} = {1}*28%	{3} ={1} - {2}
Year	Earnings before Taxes	Tax on Earnings @ 28%	Earnings after Taxes
1	420,000	117,600	302,400
2	420,000	117,600	302,400
3	420,000	117,600	302,400
4	420,000	117,600	302,400
5	420,000	117,600	302,400
6	420,000	117,600	302,400
7	420,000	117,600	302,400
8	420,000	117,600	302,400
9	420,000	117,600	302,400
10	420,000	117,600	302,400
11	420,000	117,600	302,400
12	420,000	117,600	302,400
13	420,000	117,600	302,400
14	420,000	117,600	302,400
15	420,000	117,600	302,400

.

.

Part-b:

If Connors does makes the acquisition, company’s tax liability and earnings after taxes each year over the next 15 years would be as follows:

	{1}	{2}		{3} = {1} - {2}	{4} = {3}*28%	{5} = {3} - {4}
Year	Earnings before Taxes	Losses set off against earnings	Balance Loss Carry Forward to next year	Earnings for the year after Set Off	Tax on Earnings @ 28%	Earnings after Taxes
1	420,000	420,000	530,000	-	-	-
2	420,000	420,000	110,000	-	-	-
3	420,000	110,000	-	310,000	86,800	223,200
4	420,000	-	-	420,000	117,600	302,400
5	420,000	-	-	420,000	117,600	302,400
6	420,000	-	-	420,000	117,600	302,400
7	420,000	-	-	420,000	117,600	302,400
8	420,000	-	-	420,000	117,600	302,400
9	420,000	-	-	420,000	117,600	302,400
10	420,000	-	-	420,000	117,600	302,400
11	420,000	-	-	420,000	117,600	302,400
12	420,000	-	-	420,000	117,600	302,400
13	420,000	-	-	420,000	117,600	302,400
14	420,000	-	-	420,000	117,600	302,400
15	420,000	-	-	420,000	117,600	302,400

.

.

.

Part-c:

If Salinas can be acquired for $269,000 in cash , the net benefit/loss it would have = Savings in Taxes due to set off of losses against earnings of Connors – Acquisition Cost of Salinas

=(950,000*28%) – 269,000

= 266,000 – 269,000

= -$3,000

.

.

Since , there is a net loss of $3,000 , Connors should not make the acquisition judging on the basis of tax saved.