thevalueofthetaxsavingssynergy,ifweassumethatthe
target firm could never have used the net operating loss.
Things become progressively more complicated when the
acquiring firm does not have the income to offset net
operatinglossesimmediately. Forinstance, iftheacquiring
firminthisexamplewasexpectedtogenerate$250millionin
operatingincome eachyearforthenextfouryears andthe
targetfirm’snetoperatinglosswasusedtoshelterincomein
eachyear,thesavingsintaxeswillstillbe$400million,but
spreadoutas$100millioninsavingseachyearforfouryears.
Tovaluethetaxsavingssynergy,wewouldhavetodiscount
thesecashflowsbacktothepresentataratethatreflectsthe
uncertaintyassociatedwithreceivingthebenefits.Sincethis
uncertaintyisdirectlyrelatedto thevariability inoperating
income for the combined firm,we would use the cost of
capitalofthecombinedfirmasthediscountrate.Thus,ifthe
costofcapitalofthecombinedfirmis8.10%andthesavings
are$100milliona yearforthenextfiveyears,thepresent
value of the savings can be estimated:
Therearevariationswherethecostofdebtand thecost of
equity areusedto discounttheexpected taxbenefitsfrom
debt.Thereseems to be nobasisfor usingtheformerbut
therecanbesomejustificationforusingthelatter,especially
when computing the value of equity in a company directly.
ILLUSTRATION 15.6: TaxBenefits of Writing Up Asset
Values after Takeover: Congoleum Inc.