Question

Connors Shoe Company is contemplating the acquisition of Salinas Boots, a firm that has shown large operating tax losses over the past few years. As a result of the acquisition, Connors believes that the total pretax profits of the merger will not change from their present level for 5 years. The tax loss carryforward of Salinas is $800,000, and Connors projects that its annual earnings before taxes will be $280,000 per year for each of the next 15 years. These earnings are assumed to fall within the annual limit legally allowed for application of the tax loss carryforward resulting from the proposed merger. The firm is in the 40% tax bracket.

If Connors does not make the acquisition, what will be the company’s tax liability and earnings after taxes in year 3?

Answer 1

Given :-

Tax loss carry forward = $800000

Annual earnings before taxes = $280000

Time = 15 years

Tax bracket = 40%

If Connors does not make the acquisition:-

Tax liability = Annual earnings before taxes × tax bracket

Tax liability = $280000 × 40%

Tax liability = $280000 × 0.40

Tax liability = $112000

Earnings after taxes = Annual earnings before taxes - tax liability

Earnings after taxes = $280000 - $112000

Earnings after taxes = $168000

Earnings after taxes and tax liability amount remain same for year 3 because acquisition is not made.