The assignment is twofold. First, to advise Tom Wathen as to whether he should buy Pinkerton for the asking price of $100 million. Second, regardless of your answer to #1, assuming that Wathen does buy Pinkerton, should he finance the purchase with Financing Alternative #1 (debt and equity financing from an investment firm) or Alternative #2 (all debt financing from a bank). The financing alternatives are discussed on page 4 of the case.

You should do the discounted cash flow valuation of the deal using Adjusted Present Value. The question is “What is Pinkerton worth to CPP (Wathen’s sole proprietorship)?” The value of Pinkerton to CPP is made up of three parts:

1.the value of Pinkerton as a stand-alone firm (but including improvements brought to Pinkerton by new management) plus 2.the value of synergies brought to the old CPP due to now having the combined firm plus 3.the value associated with net “financing-side” benefits associated with buying Pinkerton.

Towards calculating #1, page 3 of the case gives information necessary to build a forecast of operating free cash flows associated with Pinkerton as run with Wathen’s new strategy. There are some value drivers for which an expected scenario is given and a pessimistic scenario is given. The purpose of the pessimistic scenario is to judge downside risk. Assume that the expected scenario means “expected value.”

Towards calculating #2, there is also information given on CPP synergies on page 3 of the case.

Common to all the valuations, you have to calculate an unlevered cost of equity. Use the information on one publicly traded peer company, Wackenhut, in Exhibit 4 to estimate the unlevered cost of equity for Pinkerton cash flows. For the continuing value, use the free cash flow growth perpetuity model. Assume a perpetuity growth rate of 5% after 1992.

For financing strategy #2, the most easily quantifiable “financing-side” benefit is the tax shields...

...strongly encouraged to use spreadsheets. Refer to Note on Sample CashFlow Template.
Question 1
(5 points) The project with the highest IRR is always the project with the highest NPV.
Your Answer | | Score | Explanation |
True | | | |
False | ✔ | 5.00 | Correct. Try now to sort this out in different contexts, |
Total | | 5.00 / 5.00 | |
Question Explanation
This is all about the fundamental difference between IRR and NPV.
Question 2
(10 points) Ann Arbor is considering offering public bus service for free. Setting up the service will cost the city $0.6M (where M stands for million). The useful life of the buses is 25 years. Annual maintenance of the buses would cost $50,000 per year and they would need a major overhaul in year 15 that will cost a total of $350,000. This overhaul is in addition to the annual maintenance. Annual operating costs will begin at $90,000 in year 1 and grow at 2% per year thereafter. By using the buses as advertisement space, the city will generate a revenue of $75,000 in year 1 and it will grow at 4% per year thereafter. Reduced parking requirements and other benefits generated by the project will save the city $100,000/year. The salvage value (price city can get in the future after maintenance) of the used buses in year 25 is expected to be $150,000. What is the NPV of the bus proposal? Ann Arbor does not pay taxes and the discount rate is 5%.(Again, all cash...

...1 – Methodological Approach
In this case, American CC – the intended acquirer of AirThread Connections- will use leveraged buyout (LBO) model, which means the company will finance the acquisition through bank loan or some other borrowing methods. Hence, the debt-to-equity ratio will change in time. Since we will need to estimate the discount rate any time the capital structure changes, neither WACC nor APV would be reliable alone. Therefore, Ms. Zhang should use the combination of WACC and APV methods.
As stated above, ACC will use the Leverage buy out (LBO) approach, which means that the debt to equity ratio of AirThread will not be the same from 2008 to 2012, so APV approach would be more suitable to valuate the cashflows between 2008 and 2012.
After 2012, AirThread will de-lever to industry norm and thus, they will have a target leverage ratio; therefore WACC is best to estimate the terminal value.
Finally, regarding the valuation of non-operating investments in equity affiliates, due to limited data, market multiple approach would be better to use.
2 – Valuation of AirThread
Regarding the estimation of the long-term growth rate, Ms. Zhang knows that the long-term growth rate would be a function of the company’s return on capital (ROC) and reinvestment rate. According to the definition given in the case, ROC is defined as net operating profits after taxes divided by the book value of equity and debt. Since, there is not...

...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) cashflows in each time period
2.
Choose an appropriate discount rate
3.
Use discounted cashflow 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
FreeCashFlows
• Use method we discussed in class for calculating
FCFs. How to acount for
CapEx & Depreciation?
PP&E?...

...CONSTRUCTION OF FREECASHFLOWS A PEDAGOGICAL NOTE. PART I
Ignacio Vélez-Pareja ivelez@javeriana.edu.co Department of Management Universidad Javeriana Bogotá, Colombia Working Paper N 5
First version: 5-Nov-99 This version: January 2001
This paper can be downloaded from the
Social Science Research Network Electronic Paper Collection: http://papers.ssrn.com/paper.taf?abstract_id=196588
CONSTRUCTION OF FREECASHFLOWS
A PEDAGOGICAL NOTE. PART I1
Ignacio Vélez-Pareja ivelez@javeriana.edu.co
ABSTRACT
This is the first part of a paper where the construction of the freecashflow is studied. Usually a great deal of effort is devoted in typical financial textbooks to the mechanics of the calculations of time value of money equivalencies: payments, future values, present values, etc. This is necessary. However less or no effort is devoted to how to arrive at the figures required to calculate a NPV or Internal Rate of Return, IRR. In Part I, pro forma financial statements (Balance Sheet (BS), Profit and Loses Statement (P &L) and Cash Budget (CB) are presented. From the CB, the FreeCash...

...already visible in the increased competition in the large end of the private equity market. By knowing this right now, it is worth it to take already deals, which turn out to be interesting, before competition for deals gets even harder. Although there will be a serious contender, BC Partners, Butler has a good build-up strategy compared to BC Partners, which is a very important factor in this AD deal. Thus Butler should submit his proposal.
2. Valuation of AD and expected return:FreeCashFlow Method
To value AD we use the FreeCashFlow Method. To calculate the freecashflow streams in the future, we need to use the financial statements of AD. To look what AD will do in the future, we have to make assumptions. A part of these assumptions can be found in exhibit 18 of the case description.
To derive the freecashflow for AD, we used the following computation of the freecashflow:
Net income
+ Depreciation / amortization
- Changes in working capital
- Capital expenditure
= Freecashflow
Assumptions (amounts x1.000FFR)
Growth 1999 2000 2001 2002 2003 2004 2005 2006
Organic sales growth 2,0% 3,9% 3,7% 3,5% 3,0% 2,5% 2,5% 2,5%
Sales from acq. 378.457 582.407 676.137 762.195 778.440...

...FreeCashFlows
Revised by C. Chang. Copyright 1996 by The McGraw-Hill Companies, Inc
OUTLINE
n
n
n
n
n
n
n
What is FCF? FCFF? FCFE?
How Do You Calculate FCFF?
FCFF Calculation– the CFO Method
FCFF Calculation– the EBIT Method
Equivalence: FCFF(CFO) vs FCFF(EBIT)
FreeCashFlow to Equity (FCFE)
FreeCashFlow Example
What is FCF? FCFF? FCFE?
n
FreeCashFlows to Firm (FCFF)
n The cash produced by the business activities of a firm
available for distribution to all claimholders (debt, common
equity, preferred equity, option holders),
n
n
n
n
FreeCashFlows to Equity (FCFE)
n
n
After making ALL required investments in the business such as
working capital, property and plant and equipment, etc. needed to
sustain the firm’s assets and future growth (dependent on
decisions and strategies pursued)
Without taking into account the way the business is financed.
Exclude the tax savings from interest, because they are
included in the discount rate, WACC, or separately in APV.
The net CF available for distribution to shareholders after paying for
future investments and paying for non-equity holders
If the firm is an all equity firm, then FCFF=FCFE
How Do You...

...Freecashflow
In corporate finance, freecashflow (FCF) is cashflow available for distribution among all the securities holders of an organization. They include equity holders, debt holders, preferred stock holders, convertible security holders, and so on.
G. Bennett Stewart - the "economic model of value holds that share prices are determined by just two things: thecash to be generated over the lifetime of a business and the risk of the cash receipts”.
GSB (1990), “The Quest for Value”
FCF is the cashflow generated by a company’s operations that is free, or net, of the new capital invested for growth. Imagine all a company’s cash receipts are deposited in a cigar box, and that all of its cash operating outlays are taken out, regardless of whether they are capital expenditures on balance sheet or on income statement as expenses (where cash outflows are recorded makes no difference, unless it affects taxes). What’s left over is FCF.
Sales revenue | X |
Less: Operating costs | (X) |
Operating profit | X |
Add: depreciation | X |
Less: cash tax | (X) |
Operating cashflow | X |
Less: investment in fixed assets | (X) |
Less: investment (change) in working capital | (X) |
FreeCash...

...Communication want to raise capital by Leveraged Buyout (LBO) approach. This means ACC will finance money though equity and debt to buy AirThread and pay the debt by the cashflows or assets of AirThread.
* In another word, it’s a highly levered transaction using a fixed WACC discount rate; however the leverage is changing in fact.
* If we want to use WACC method, one assumption must be met: this program will not change the debt-equity ratio of AirThread. Under LBO approach, it’s impossible.
* So we decide to use APV method to value AirThread. WACC method is not appropriate here, but we still need to calculate the weight average cost of capital (WACC) of AirThread.
Approach to value AirThread before considering any synergy
1. Develop a projection of unlevered freecashflow for AirThread.
* Discount AirThread’s unlevered freecashflows at unlevered WACC.
2. Determine the PV of interest tax shield:
* Discount AirThread’s interest tax shield by debt cost of capital (interest rate of debt).
3. Add the unlevered value to the PV of interest tax shield to get the value of the acquisition.
4. Using Dividend Discount Model (Gordon Growth Model) to estimate the terminal value.
5. Estimate the value of operating assets based on the above (without synergies).
6. Add the value of non-operating assets (excess cash, securities,...

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