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Part 1

Tax benefits and priceHahn Textiles has a tax loss carry forward of

$800,000.

Two firms are interested in acquiring Hahn for the tax loss advantage. Reilly Investment Group has expected earnings before taxes of

$200,000

per year for each of the next 7 years and a cost of capital of

14.7%.

Webster Industries has expected earnings before taxes for the next 7 years as shown in the following table,

1 $79,000 2 $118,000 3 $200,000 4 $298,000 5 $398,000 6 $400,000 7 $500,000

.

Both Reilly's and Webster's expected earnings are assumed to fall within the annual limit legally allowed for application of the tax loss carryforward resulting from the proposed merger. Webster has a cost of capital of

14.7%.

The corporate tax rate is

21%.

a.What is the tax advantage of the merger each year for Reilly?

b.What is the tax advantage of the merger each year for Webster?

c.What is the maximum cash price each interested firm would be willing to pay for Hahn Textiles?

(Hint:

Calculate the present value of the tax advantages.)

d.Use your answers in parts a through c to explain why a target company can have different values to different potential acquiring firms.