Free Cash Flow

Pinkerton case - General
Create NPV
“Be Big”

• Check out case instructions on bspace & begin working with your group Historical case – CPP’s bid to acquire Pinkerton security guard firm in the late 1980s
Provide executive summary & detailed analysis of value of acquisition Email your group’s bid to GSI before 6 p.m. evening before discussion Be prepared to discuss the case in class (your answers, your analysis, etc.)

1

Valuation - Use NPV approach
How to make investment decisions:
1.

Estimate (expected) cash flows in each time period

2.

Choose an appropriate discount rate

3.

Use discounted cash flow analysis to calculate NPV

4.

Make decision that maximizes NPV

Fundamental principle: V(A+B)>V(A)+V(B)
Value driver:1)Eliminate overhead
3) Leveragen brom dname
Pay its=D(P)(P-VC)-FC

V(Pinkerton after)+V(CPP after)>V(Pinkerton before)+V(CPP before)
V(Pinkerton after)+∆V(CPP)>V(Pinkerton before)
NPV=∑FCF(Pink,t)/(1+WACC)^t+∑∆FCFcpp.t/(1+WACC)^t
t t Landing list:
1) Find WACC
2)Estimate FCFpink
3)Estimate∆FCFcpp

2

1. Use FCF analysis
• Case provides information about value drivers of the acquisition • Combine with accounting information to estimate
Free Cash Flows
• Use method we discussed in class for calculating
FCFs. How to acount for
CapEx & Depreciation?
PP&E?
NWC?
Interest payments?

3

1. Separate into short and terminal terms p=[ROE*(BVPS*Payout Ratio)]/(r-g)

In valuing a business, we typically forecast cash flows only for a certain period, e.g.:

C1
P
1 r

C2
1 r

2

C5
1 r

5

P5
.
5
1 r

– The expected future value, P5, is called the terminal value, continuing value, or residual value
– Can estimate it by forecasting cash flows from year 6 on, e.g. growing perpetuity

P5

C5 (1 g)
.
r g

4

2. Use WACC method for discount rate
• Use the WACC method with taxes
• Think (a lot) about how to come up with appropriate estimates for the variables that determine the WACC
WACC=D/D+E (1-Tc)rD+E/D+E * RE Tc=34%
D/D+E: use Wac D=10.6