Posted: April 14th, 2021
1. 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 carryforward
resulting from the proposed merger (see footnote 2 on page 719). 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.)
2. Asset acquisition decision Zarin Printing Company is considering the acquisition of Freiman Press at a cash price of $60,000. Freiman Press has liabilities of $90,000. Freiman has a large press that Zarin needs; the remaining assets would be sold to net $65,000. As a result of acquiring the press, Zarin would experience an increase in cash inflow of $20,000 per year over the next 10 years. The firm has a 14% cost of capital.
a. What is the effective or net cost of the large press?
b. If this is the only way Zarin can obtain the large press, should the firm go ahead with the merger? Explain your answer.
c. If the firm could purchase a press that would provide slightly better quality and $26,000 annual cash inflow for 10 years for a price of $120,000, which alternative would you recommend? Explain your answer.
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