=+P18–1 Tax effects of acquisition Pen and Paper Ltd. is considering the acquisition of Paper Mill Company, a firm that has reported large operating tax losses over the past few years. After some analysis, Pen and Paper Ltd. found that the total pretax profits of the acquisition would not change from their current level for 10 years. The tax loss carryforward of Paper Mill is $7.4 million. Pen and Paper Ltd. projects that its annual earnings before taxes will be $2.5 million per year for the next 10 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 (see footnote 2 earlier in this chapter). Both firms have a 40% tax rate.