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17.1

which has a tax-loss-carryforward benefit of $600,000, Burton Corporation has earnings of

$500,000 in 19x1 and $800,000 in 19x2. The tax rate is 46 percent. Determine the tax to be paid

by Burton in 19x1 and 19x2.

SOLUTION

$500,000

In 19x1: Burton Corporation earnings

500,000

Weiss tax loss carryforward

Taxable income $ 0

Tax $ 0

Burton Corporation earnings $800,000

In 19x2:

Unused Weiss Corporationâ€™s tax loss

carryforward ($600,000- $500,000) 1oo,oO0

Taxable income $700,000

Tax (46% rate) $322,000

1.

72 Acquisition of a Company. Yohai Corporation is thinking of purchasing Klein Corporation for

$70,000 in cash. Yohaiâ€™s current cost of capital is 16 percent. Kleinâ€™s estimated overall cost of

capital is anticipated to be 14 percent after the acquisition. Forecasted cash inflows from years

1 to 15 are $8,000. Should the acquisition be made?

SOLUTION

Present Value

Calculations

Year 0 -$70,000 X 1 -$70,000

+ $8,000 X 6.142

Years 1-15 +49,136â€œ

Net present value -$20,864

â€œUsing 14 percent as the discount rate.

Since the net present value is negative, the acquisition should not be made.

427

MERGERS AND ACQUISITIONS

CHAR 171

Acquisition of Assets for Cash. Master Corporation wants to buy certain fixed assets of Smith

17.3

Corporation. However, Smith Corporation wants to dispose of its entire business. The balance

sheet of Smith follows:

ASSETS

Cash $ 2,000

8,000

Accounts receivable

20,000

Inventories

10,Ooo

Equipment 1

20,000

Equipment 2

35,000

Equipment 3

90.000

Building

$185,000

Total assets

LIABILITIES AND

STOCKHOLDERSâ€™ EQUITY

Total liabilities $ 80,000

Total stockholdersâ€™ equity 105,Ooo

Total liabilities and stockholdersâ€™

equity $185,000

Master needs only equipment 1and 2 and the building. The other assets excluding cash can

be sold for $35,000.Smith wants $48,000for the entire business. It is anticipated that the after-tax

cash inflows from the new equipment will be $30,000 a year for the next 8 years. The cost

of capital is 12 percent.

( a ) What is the initial net cash outlay? (6) Should the acquisition be made?

SOLUTION

Total payment:

Liabilities $80,000

$128,000

Owners 48,000

+ $35,000) 37,000

Cash available ($2,000

$ 91,000

Initial net cash outlay

Calculations Present Value

-$91,000 x 1

Year 0 -$ 91,000

+ 149,040

+$30,000X 4.968

Years 1-8

Net present value +$ 58,040

Since the net present value is positive, the acquisition should be made.

Acquisition of Assets for Cash. Knab Corporation is considering acquiring Deerson Corporation

17.4

for $40,000.Deerson has liabilities of $62,000.Deerson has machinery that Knab wants, and the

remaining assets would be sold for $55,000. The machinery will furnish Knab with an increase

in annual cash flow of $7,000 for the next 10 years. The cost of capital is 12 percent.

( a ) What is the net cost of the machinery? (6) Should the acquisition be made?

428 MERGERS AND ACQUISITIONS [CHAP. 17

$40,000 + $62,000 - $55,000 = $47,000

Calculations Present Value

-$47,000

-$47,000 X 1

Year 0

Years 1-10 $7,000 X 5.650 +39,550

Net present value -$ 7,450

Since the net present value is negative, the acquisition should not be made.

Acquisition by Exchanging Stock. Company R wishes to acquire company S. Company R's stock

17.5

sells for $100 per share. Company S's stock sells for $40 a share. Due to merger negotiations,

company R offers $50 a share. The acquisition is done through an exchange of securities. What

is the ratio of exchange?

SOLUTION

Amount paid per share of the acquired company - $50

--= 0.5

Market price of the acquiring company's shares $100

Earnings per Share. The following data concerning companies A and B are presented:

1.

76

Company A Company B

Net income $35,000 $50,000

'

Shares outstanding 5,000 10,000

Earnings per share $7.00 $5.00

P ratio

E 10 14

Market price $70 $70

Company B is the acquiring company, exchanging its shares on a one-for-one basis for

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