Chapter 18, Problem 18.1P

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 footnote² earlier in this chapter). The firm is in the 40% tax bracket.

1. a. If Connors does not make the acquisttion, what will be the company’s tax liability and earnings after taxes each year over the next 15 years?
2. 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?
3. 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.)