IH Corporation, a farm equipment manufacturer, has accumulated almost $2 billion in losses over the past seven years of operations and is in danger of not being able to carry forward these losses. EG Corporation, an extremely profitable financial service firm, which had

$3 billion in taxable income in its most recent year, is considering acquiring IH Corporation. The tax authorities will allow EG Corporation to offset its taxable income with the carried-forward losses. The tax rate for EG Corporation is 40%, and the cost of capital is 12%.

a. Estimate the value of the tax savings that will occur as a consequence of the merger.

b. What is the value of the tax savings if the tax authorities allow EG Corporation to spread the carried-forward losses over four years (i.e., allow $200 million of the carried-forward losses to offset income each year for the next four years)?