Question

Clark Ski Company is considering an acquisition of Sally Parka Company, a firm that has had big tax losses over the past few years. As a result of the acquisition, Clark believes that the total pretax profits of the merger will not change from their present level for 5 years. The tax loss carryforward of Sally 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.

2.   If Clark does not make the acquisition, what will be the company’s tax liability and earnings after taxes in Year 3?

  

3.   If the acquisition is made, what will be the company’s tax liability and earnings after taxes in year 3?

Answer 1

Tax	40%
Without merger
Clark co	1	2	3
Profit	280000	280000	280000
Tax @ 40% pr tax liability	112000	112000	112000
Net profit = Profit - Tax	168000	168000	168000
Earnings = Net Profit
With merger
Clark co	1	2	3
Profit	280000	280000	280000

Tax loss carry forward of Sally company would act as advantage for Clark co because that would decrease its taxable profits

Tax loss carry forward			80000
Tax @ 40% pr tax liability	112000	112000	32000
Net profit = Profit - Tax	168000	168000	248000
Earnings = Net Profit