I would recommend financial strategies # 2 – $100 million purchase price funded by 100% debt. (This is before I did free cash flow forecast for # 9). It will provide the highest tax shield of $17. 49 million for CPP. In addition, Pinkerton has the highest value of $107. 34 million under this strategy. 7. Below is the balance sheet after CPP and Pinkerton acquisition. * CPP market value leverage ratio is 7. 46% and book value leverage is 14. 69% before acquisition. * After acquisition, with $75 million debts, the market value leverage ratio is 52. 9% and the book value leverage ratio is 64. 49%. * After acquisition, with 100 million debts, the market value leverage ratio is 69. 95% and the book value leverage ratio is 85. 14%. 8. Below is the transaction of loss equity. CPP receives $25 million from the bank but gives up $32. 58 million to the bank for the promised 45% equity after acquisition. The cost of doing equity issue is $7. 58 million. Equity Issue with $ 75 million debt| Value of Combined CPP| 147. 4| Minus Long term debt| 75| Equity| 72. 4| Minus 45% to banks| 32. 58| CPP receive| 25| Loss| 7. 58| 9.
From the expected cash flow table below, CPP has extra free cash flow by financing $75 million debt compare to financing $100 million. Both strategies provide positive free cash flow for the next five years. From the Pessimistic cash flow table below, CPP has more cash flow by financing $75 million debt compare to financing $100 million. $75 million debt strategy provides positive cash flow for the next five years. On the other hand, $ 100 million debt financing will lead to negative cash flow on the fourth and fifth year. 10. * I would recommend Tom Wathen to bid on Pinkerton.
The acquisition with Pinkerton will create synergy and bring incremental free cash flow to CPP. According to the valuation, the value of CPP is about $ 41. 53 million and the value after acquisition will increase to $147 million. * Initially, CPP bided $85 million but was rejected. From the valuation, Pinkerton is worth $108 million (include incremental value) at the expected value and $85 million (include incremental value) at the pessimistic value. If you take the average of $108 million and $85 million it comes to $96 million. Therefore, I would recommend Wathen to bid $96 million.
This would ensure that Wathen’s bid would come in at the right price and not be lower than other bidders. * After doing the free cash flow forecast for the next five years there was negative cash flow with $100 million debt in pessimistic period. Wathen should finance $96 million with 75% in debt ($72 million) and $24 million in equity in exchange for 31 % of the equity in the new combined firm. By doing this, it will ensure no equity loss to the bank. In addition, with $72 million in debt and $24 million in equity will ensure no negative cash flow when the economy is bad (in pessimistic period).