Pinkerton (A) Case Study Solution
In addition to this, the company would get benefits from the value of incremental tax shield of $13.6 million, which means that the amount of tax liability would be deducted due to the interest expense. Furthermore, the company would gain benefits from the estimated base case continuing value of $38.7 million, which means that the acquisition would pay never-ending cash streams toCPP.
How should Mr. Walthen finance the acquisition or Pinkerton? Pick only one.
$100M in debt
Under the optimistic scenario; the total free cash flows are calculated by adding CCP free cash flows provided in the exhibit 3, Pinkerton free cash flows and incremental CCP free cash flows. Thus, the total free cash flows of the company under the optimistic scenario, are positive, providing a strong foundation of pursuing the acquisition decision of Pinkerton.
There are two options of financing Pinkerton, first the company would raise $100 million through $75 million debt structure at the interest rate of 11.5 percent together with $25 million equity investment for the 45 percent equity stake in the combined company and raise $100 million debt facility at the interest rate of 13.5 percent.
If the company intends to raise $100 million debt facility at the interest rate of 13.5 percent; the total cash flows after deducting the debt service burden would be positive but lower than the free cash flows calculated after raising $100 million debt at interest rate of 11.5 percent, which shows that the company should raise $100 million debt facility at the rate of 13.5 percent, to generate high cash flows over the period of time.
Under the pessimistic scenario, the total cash flows of the company are calculated by adding CCP’s free cash flows and Pinkerton’s cash flows, thus resulting in the positive returns over the period of projected years, but lower than the cash flows calculated under the optimistic scenario. If the company indents to raise $100 million debt facility at the interest rate of 13.5 percent; the total cash flows of the company would be negative in year 1991 and 1992.
$75M in debt and $25M in equity
If the company intends to raise $100 million through $75 million debt structure at the interest rate of 11.5 percent; the total debt service burden would be 5.69 million dollars each projected year and the total free cash flows after deducting the debt service burden would be positive for the projected years.
Under the pessimistic scenario; the total cash flows of the company are calculated by adding CCP’s free cash flows and Pinkerton’s cash flows, thus resulting in positive returns over the period of projected years, but lower than the cash flows calculated under the optimistic scenario. If the company indents to raise $100 million debt facility at the interest rate of 11.5 percent; the total cash flows of the company would be positive from 1988 to 1992.
Recommendation
Taking under consideration the evaluation of the acquisition decision based on discounted cash flow methods; Mr. Wathen is advised to exploit the opportunity of acquiring Pinkerton because of the fact that the acquisition would present various benefits to his company, such as:it would help CPP in becoming the biggest firm in the industry and it would provide various other benefits, such as:new resources and competencies, fresh perspective and idea, synergies, increased market share and value of incremental improvements.(Goddard, 2018).
In addition to this, the valuation of the Pinkerton provides strong foundation of acquiring in the business as the standalone value of the company amounts $37.95 million and the estimated value of the acquisition of Pinkerton is $113.506, which is significantly greater than $100 million bid price. Additionally, the analysis of the financing Pinkerton shows that the company needs to finance the deal with 75% debt at the interest rate of 11.5 percent.It is because of the reason that the company would be able to enjoy the positive cash flows even after deducting the total service burden under both optimistic and pessimistic scenarios.Whereas, if the company would finance the deal with $100 million debt at the rate of 13.5 percent, it would lose its returns over the period of time under both scenarios.
Conclusion
Wathen was presented with two options, i.e. to finance the bid of Pinkerton by either $75 million at the rate of 11.5 percent interest or 100 million dollar debt at 13.5 percent interest. The present value of free cash flows at equity cost of capital amounts $45.21 million. The positive cash flows for the company shows that the acquisition of Pinkerton would provide greater financial outcomes to CPP. The net present value of the acquisition of Pinkerton is $37.95 million, which shows that the decision of acquiring Pinkerton would be feasible and viable for the company and would help in generating greater financial outcomes.
The value to CPP from the acquisition of Pinkerton is calculated on the basis of four sources, which are: value of incremental improvements to CPP, estimated base case continuing value at times 0, value of incremental tax shields and present value at all-equity cost of capital.Since CPP in expert in the business of security guard, there is a likelihood that CPP would successfully improve the performance of Pinkerton. The company needs to finance the deal with 75% debt at the interest rate of 11.5 percent,because the company would be able to enjoy the positive cash flows even after deducting the total service burden under both optimistic and pessimistic scenarios.........
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