Tax effects of acquisition Connors Shoe Company

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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 lia-
bility 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 acqui-
sition, 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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