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 15.2%. Webster Industries has expected earnings before taxes for the next 7 years as shown in the following table, Year Earnings before taxes 1 $79,000 2 $122,000 3 $198,000 4 $302,000 5 $400,000 6 $400,000 7 $501,000 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 15.2%. The corporate tax rate is 21%. 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.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter9: Capital Budgeting And Cash Flow Analysis

Section: Chapter Questions

Problem 11P

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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 15.2%. Webster Industries has expected earnings before taxes for the next 7 years as shown in the following table,


Year		Earnings before taxes
1		$79,000
2		$122,000
3		$198,000
4		$302,000
5		$400,000
6		$400,000
7		$501,000

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 15.2%. The corporate tax rate is 21%.

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.

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