Test bank chapter 1 Introduction

Solution: Present value = $90,000 + $30,000 = $1,200,000.

26. A Canadian company has a total of $450,000 in tax loss carryforwards. To use these losses and to diversify its operations, a US company has acquired the Canadian company through a merger. The US company expects to have earnings before taxes of $300,000 per year. Assume: the US company is in the 40-percent tax bracket and all the losses can be carried forward. How much tax can the US company reduce through this merger?

* A. $180,000
B. $250,000
C. $300,000
D. $450,000
E. $500,000


Solution: Reduction in tax = the loss involved multiplied by the tax rate:
$450,000 x 0.40 = $180,000.

27. Assume that the debt ratio is 60 percent, the cost of debt is 6 percent, the cost of equity is 10 percent, the tax rate is 50 percent, and annual earnings after taxes are $10,000 for a multinational company. What are the company's weighted average cost of capital and its market value?

A. 5.8%, $150,000
* B. 5.8%, $172,414
C. 6.2%, $172,414
D. 6.9%, $190,214
E. 7.7%, $200,000


Solution: Weighted average cost of capital = 0.60 x 0.06(1 - 0.50) + 0.40 x 0.10 = 0.058.
Market value = $10,000/0.058 = $172,414.

28. Assume that a company with a tax rate of 40 percent has acquired a firm with $5 million book value for $12 million. The acquiring company is located in a country where goodwill write-offs are deductible for tax purposes. The goodwill can be written off for a maximum of ten years. What is the amount of tax savings that the acquiring company can realize for ten years?

A. $2.1 million
B. $2.5 million
* C. $2.8 million
D. $3.5 million
E. $4.8 million


Solution: Goodwill = market value - book value
= $12 million - $5 million = $7 million.
Tax savings = goodwill x tax rate