You are a newly hired analyst at a large Wall Street investment bank and your direct supervisor has in-formed you that Arnie’s Army (the acquirer) has engaged your firm to analyze the prospect of acquiring JM, Inc., a wholly owned subsidiary of Nicklaus. Consider the following relevant facts.
• JM has assets with a net tax basis of $ 300 million and a fair market value of $ 900 million. JM has no liabilities.
• JM is 100% owned by Nicklaus.
• Nicklaus has a tax basis in JM stock of $ 600 million. Nicklaus acquired this stock 5 years ago.
• Arnie’s Army wants to acquire the stock of JM from Nicklaus for $ 900 million in cash.
• JM, Nicklaus, and Arnie’s Army are all C corporations.
• Assume the transaction is structured as a taxable stock sale without a Section 338(h)(10) election.
a. What tax basis in the assets of JM will Arnie’s Army have post- acquisition?
b. How much cash after tax will Nicklaus’ have from the transaction? Assume that ­Nicklaus’ marginal tax rate is 40%. Assume that the transaction is structured as a taxable stock sale with a Section 338(h)(10) election.
c. What tax basis in the assets of JM will Arnie’s Army have post acquisition?
d. How much cash after tax will Nicklaus have? Assume that Nicklaus’ marginal tax rate is 40%. e. At what price (P) is Nicklaus indifferent between a stock sale with a Section 338(h)(10) and a stock sale without a Section 338(h)(10) election at a $ 900 million ­purchase price?
f. Given the price (P) that you computed in part (e), which structure does Arnie’s Army prefer: a tax-able stock sale without a Section 338(h)(10) election for a price of $ 900 ­million or a taxable stock sale with a Section 338(h)(10) election at price (P)? Assume any basis step- up in JM’s assets in a Section 338(h)(10) transaction is depreciated/ ­amortized over 12 years and that the appropriate discount rate for any tax savings from these ­additional deductions is 7%. Assume that Arnie’s Army’s tax rate is 40%.
g. Should the Section 338(h)(10) election be made? Why or why not?
h. If Arnie’s Army captured all the net tax benefits associated with the Section 338(h)(10) election (assuming that your answer to part [ g] is yes), how much lower would its net after- tax cost be relative to a sale without a Section 338(h)(10) election at a $ 900 million purchase price?
i. If Nicklaus captured all the net tax benefits associated with the Section 338(h)(10) ­election (assuming your answer to part [g] is yes), how much higher would its after- tax wealth be relative to a sale without a Section 338(h)(10) election at a $ 900 million ­purchase price?