Find the Optimal Divestiture Structure and Price for VALLARTA Inc

You are a newly minted MBA starting a full time job at a large Wall Street investment bank and your direct supervisor has informed you that HEETER (the acquirer) has engaged your firm to analyze the prospect of acquiring VALLARTA, Inc. from HAMACHI, Inc. VALLARTA is a wholly owned subsidiary of HAMACHI.

The relevant facts appear below:

1. VALLARTA has assets with tax basis of $100 million and FMV of $775 million. The assets have a historical cost of $700 million and have accumulated depreciation of $600 million. VALLARTA has no liabilities.
2. VALLARTA is 100% owned by HAMACHI.
3. HAMACHI has a tax basis in VALLARTA stock of $575 million. HAMACHI acquired this stock 5 years ago.
4. HEETER wants to acquire the stock of VALLARTA from HAMACHI for $775 million in cash.
5. VALLARTA, HAMACHI and HEETER are all C-Corporations.
6. HAMACHI had a $150 million capital loss carryforward that will expire this year. It does not expect to generate any capital gains this year, other than those generated in the deal.
7. Assume that all gains that are recaptured depreciation are taxed as ordinary income.

Assume that the transaction is structured as a taxable stock sale with a 338(h)(10) election.

1. What tax basis in the assets of VALLARTA will HEETER have post-acquisition
2. How much cash after tax will HAMACHI have? Assume that HAMACHI's marginal tax rate is 20%.
3. At what price (P) is HAMACHI indifferent between a stock sale with a 338(h)(10) and a stock sale without a 338(h)(10) election at a $775 million purchase price.
4. f) Given the price (P) that you computed in part e), which structure does HEETER prefer (a taxable stock sale WITHOUT a 338(h)(10) election for a price of $775 million or a taxable stock sale WITH a 338(h)(10) election at price P? Assume that any step-up in the tax basis of VALLARTAs assets in a 338(h)(10) transaction is depreciated/amortized straight line over 10 years and that the appropriate after-tax discount rate for any tax savings from these additional deductions is 7%. Assume that HEETER's tax rate is 20%.