Question

Tax benefits and price Hahn Textiles has a tax loss carryforward of $802,000 Two firms are interested in acquiring Hahn for the tax loss advantage. Reilly Investment Group has expected earnings before taxes of $200,500 per year for each of the next 7 years and a cost of capital of 14.9% Webster Industries has expected earnings before taxes for the next 7 years as shown in the following tablo, 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. Webster has a cost of capital of 14.9% Both firms are subject to a 38% tax rate on ordinary income a. What is the tax advantage of the merger each year for Reilly? b. What is the tax advantage of the merger each year for Webster? c. What is the maximum cash price each interested firm would be willing to pay for Hahn Textiles? (Hint Calculate the present value of the tax advantages.) d. Use your answers in parts a through c to explain why a target company can have different values to different potential acquiring firms a. Reilly's tax advantage from the acquisition in year 1 is S (Round to the nearest dollar) i Data Table (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Year Webster Industries Earnings before taxes $79,000 $120,000 $202.000 $300,000 $400,000 $399,000 $499,000 Enter your answer in 16 parts Check Answer Print Dan

Answer 1

ER (Date: a. Reilly's tax acquisition advantage from the will be as follows calculation of Net Earnings before taxes year carry forward Tax Loss (Balance) Net Earnings After Set off of Losses (4)= (2) $ 802,000 $ 602500=($802000 - $ 200500 $ 401000 $ 200 500 Nil Nil Nil Expected Fartings Befor Tax (3) $ 200500 $2005oo $ 200 500 $ 200 500 $ 200500 $ 200 500 $ 200 500 $ 200500 $ 200500 $ 200, 500 calculation of Tax Advantage Tax After merger (3) Nil Nil Year Tar Amount Before merger (2 ) $76, 190 $76, 190 $26,190 $76, 190 $ 76,190 6 $76, 190 $76,190 $533,330 rac Advantage of acquisition (4) $76.190 $76,190 $ 26,190 $76,190 Nil Nil Mil $304760 Nil $76190 $76190 $76190 $225 570

Date: 11 acquisition Webster's tax advantage from will be as follows calculation of Net Earnings Before Taxes year carry forward por loss (Balance) Expected Earnings Before Tax Net Earnings after setoff of losser (4) Nil Mil -am not (2) $ 802,000 * 323,000 $ 603,000 $ 401,000 $ 101,000 Nil Nil $ 79 000 $ 120,000 $ 202,000 $ 300,000 $ 400,000 $ 399,000 $ 499,000 Nil Nil $ 299000 $ 399,000 $ 499,000 calculation o ť Tax Advantage year Tax Acquisition advantage (1) toutwN Tax Amount Before merger (2) $ 30020 $ 45,600 $ 76,760 $ 114,000 $ 152,000 $ 151620 $ 1896 20. $ 759,620 Tax Amount After merger (3) Nil Nil Nil Nil $ 113 620 $ 151620 $_189620 $ 454860 $ 30020 $ 45,600 $ 76,760 $ 114,000 $38,380 $ Nil II $304,760

Date: 1 cash to rice f firms would be for Hann Textiles maximum interested would be Reilly year Cio (2) Tax Advantage present Value Present value of Factor @ 14.9% Tax Advantage. (4) = 2 x 3) $76,190 0.870 $ 66,310 $76,190 0.757 $ 57,711 $76,1go 0.659 $ 50,223 $76,190 0.574 $ 43,314 $217,962 maximum cash price by Reilly would be $ 217,962 Webster year (1) Tax Advantage Present valur pr. of Tax factar @ 14.9%. Advantage (2) (3) (4) $30020 0.870 $ 26,117 $ 45,600 0.757 $34, 519 $ 76,760 0. 659 $ 50585 $ 114000 0.574 $ 65436 $ 38,380 0.499 $1915 $ 130373 mazimum Cash Poice by Webster would be $ 130,373

Date: 11 Values to potential acquiring firms depends on advantages (financial) gained from acquired firms. Reilly is earning high cconsistently) during earlier years, but webster earnings are on increasing trend which means it has lower earnings in earlier year. Earlier Tax advantages to firms gives more value to acquired firms because of higher present value factors during earlier years. values to advana -tages decrease in later years. As we can see in problem, Reilly has higher tax advantaget in earlier years compared to websters and thats why it has more value to firm than webster.