California Plant Protection (CPP) is a medium sized security firm, which is considering expanding their business by buying a larger firm named Pinkerton. The first bid was $85 million but this was rejected, and CPP was informed that any bids under $100 million would face the same result. The key questions we have addressed are whether a $100 million bid for Pinkerton can be justified and if so, how the acquisition should be financed.
We find the value of Pinkerton for CPP to be greater than $100 million and that financing alternative 1 generates the greatest value for CPP. Based on this we recommend Wathen to increase the bid to $100 million and finance this with 75% debt and 25% equity.
In the process of making an estimate of the value of Pinkerton’s future cash flow, we based the numbers on the task force’s expectations. There are no indications of Pinkerton having any debt to consider, and therefore we chose the Equity DCF method to estimate the value, and for this we needed a discount factor. This was found by using the unlevered cost of equity based on data from Wackenhut.
Exhibit A shows the expected DCF after implementing the new pricing strategy of Pinkerton, but without any synergies or financing cost. If the task force’s expected estimations are correct the value of Pinkerton is $104.87 million. However if their more pessimistic estimations occur, the value may drop to approximately $78.31 million. In addition buying Pinkerton will result in certain synergies which we have estimated to be $18.26 million. This calculation is shown in exhibit B. Whether a bid of $100 million is justified depends on the actual future state. We find it most reasonable to assume a state somewhere between the task force’s pessimistic and optimistic expectations. This brings us to using the average value of Pinkerton for CPP which amounts to $109.85 million, indicating that a bid of $100 million is justified. To triangulate our...