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Impact of Tax Loss Carryforward on Value

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Hahn Textiles has a tax loss carryforward of $8000,000. Two firms are interested in acquiring Hahn for the tax loss advantage. Reilly Investment Group has expected earnings before taxes of $200,000 per year for each of the next 7 years and a cost of capital of 15%. Webster Industries has expected earnings before taxes for the next 7 years as shown in the following table.

Webster Industries
Year Earnings before taxes
1 $ 80,000
2 120,000
3 200,000
4 300,000
5 400,000
6 400,000
7 500,000

Both Reilly's and Webster's expected earnings are assumed to fall within the annual limit legally allowed for application of the tax loss carry forward and resulting from the proposed merger. Webster has a cost of capital of 15%. Both firms are subject to a 40% tax rate on ordinary income.
a. What is the tax advantage of the merger for each year for Reilly?
b. What is the tax advantage of the merger for each year for Webster?
c. What is the maximum cash price each interested firm would be willing to pay for Hahn textiles?
d. Use the 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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Solution Summary

How does tax loss carryforward impacts the value of a company to a potential acquirer?

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Financial Management

Provide computation and formulas on how to calculate the following:

1. Hughes Technology has had net income of $450,000 in the current fiscal year. there are 100,000 shares of common stock outstanding with convertible bonds, which have a total face value of $1.2 million. the $1.2 million is represented by 1,200 different $1,000 bonds. Each $1,000 bond pays 6 percent interest. The conversion ration is 20. The firm is in a 30 percent tax bracket.
(a) Calculate Hughes's basic earnings per share.
(b) Calculate Hughes's diluted earnings per share.

2. Meyers Business systems has 2 million shares of stock outstanding. Earnings with warrants after taxes are $4 million. Meyers also has warrants outstanding, which allow the holder to buy 100,000 shares of stock at $10 per share. The stock is currently selling for $40 per share.
(a) Compute the basic earnings per share.
(b) Compute diluted earnings per share considering the possible impact of the warrants. use the formula:

Earnings after taxes
Shares outstanding + Assumed net increase in shares from the warrants

3. Assume that citrus Corporation is considering the acquisition of Orange Juice, Inc. The latter has a $500,000 tax loss carryforward. Projected earnings for the Citrus Corporation are as follows:
2004 2005 2006 Values
Before-tax income........ $200,000 $250,000 $380,000 $830,000
Taxes (40%) ............. 80,000 100,000 152,000 332,000
Income available to
Stockholders.......... $120,000 $150,000 $228,000 $498,000
(a) How much will the total taxes of Citrus Corporation be reduced as a result of the tax loss carryforward?
(b) How much will the total income available to stockholders be for the three years if the acquisition occurs? use the same format as that on pages 614 and 615 of this chapter (Ref: Financial management Course 661, Chapters 19 through 21).Lesson 28.

4. Assume the following financial data for Noble Corporation and Barnes Enterprises:
Total earnings.......................... $1,200,000 $3,600,000
Number of shares of stock outstanding... 100,000 2,400,000
Earnings per share...................... $2.00 $1.50
Price-earnings ratio (P/E).............. 24X 32X
Market price per share.................. $48 $48

(a) If all the shares of Noble Corporation are exchanged for those of Barnes Enterprises on a share-for-share basis, what will postmerger earnings per share be for Barnes Enterprises? Use an approach similar to that in Table 20-3 on page 619. (ref:Finance Management course 661, chapters 19 through 21, Lesson 28).
(b) Explain why the earnings per share of Barnes Enterprises changed.
(c)Can we necessarily assume that Barnes Enterprises is better off after the merger?

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