Chapter 18, Problem 18.2P

Tax effects of acquisition Trapani Tool Company is evaluating the acquisition of Sussman Casting. Sussman has a tax loss carryforward of $1.8 million. Trapani can purchase Sussman for $2.1 million. It can sell the assets for $1.6 million, their book value. Trapani expects its earnings before taxes in the 5 years after the merger to be as shown in the following table.

Year	Earnings before taxes
1	$150,000
2	400,000
3	450,000
4	600,000
5	600,000

The expected earnings given are assumed to fall w1th1n the annual limit that is legally allowed for application of the tax loss carryforward resulting from the proposed merger (see footnote ²). Trapani is in the 40% tax bracket.

1. a. Calculate the firm’s tax payments and earnings after taxes for each of the next 5 years without the merger.
2. b. Calculate the firm’s tax payments and earnings after taxes for each of the next 5 years with the merger.
3. c. What are the total benefits associated with the tax losses from the merger? (Ignore present value.)
4. d. Discuss whether you would recommend the proposed merger. Support your decision with figures.