Boardwalk Corporation desires to expand. It is considering a cash purchase of Park Place Corporation for $2,400,000. Park Place has a $600,000 tax loss carryforward that could be used immediately by Boardwalk, which is paying taxes at the rate of 35 percent. Park Place will provide $300,000 per year in cash flow (aftertax income plus depreciation) for the next 20 years. If Boardwalk Corporation has a cost of capital of 11 percent, should the merger be undertaken?© BrainMass Inc. brainmass.com October 25, 2018, 12:12 am ad1c9bdddf
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In order to decide we need to calculate the NPV of the merger.
The initial investment is $2,400,000 less the tax shield from the loss ...
The solution explains how to evaluate a merger when there is a Tax loss Carry forward
Impact of Tax Loss Carryforward on Value
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.
Year Earnings before taxes
1 $ 80,000
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.