Pinkerton Assignment

1)
a. Pinkertons tax benefits of debt are higher or lower?

Compared to a average firm, Pinkertons tax benefits are way higher, since it is
mainly financed by debt.

b. Pinkertons probability of financial distress is higher or lower?

The probability of financial distress of Pinkerton is higher than an average firm,
since it has high leverage. Perhaps even bankruptcy.

c. Pinkertons costs of financial distress if the firm actually finds itself in financial
distress are higher or lower? What do you think is the most important cost of
financial distress for Pinkerton

The cost of financial distress is way higher because they have a higher debt. Plus,
they decided to allow Berkley to buy shares and to MHTC the right to purchase up to
5% of the common stock. The most important cost of financial distress is that they
are not able to acquire new security firms. They do not have the required funds to
invest into positive NPV projects. They are already losing clients due to premium
pricing. They also have underinvestment due to the debt overhang.

d. The incentive benefits of debt are higher or lower?

Higher, because the higher the debt, the higher the incentive benefits of it

e. Based on the above, should Pinkerton take on more or less debt relative to
anaverage firm?

Since Pinkerton get a higher incentive of benefits of debt, it should take more debt
than an average firm.

f. Do you think Pinkerton has too much or too little debt as of January 1, 1990?
Even thought they should have more debt than the average, they have way too much
debt.


2.
a. Do you think Berkeley is likely to use its warrants?

Yes of course, they have the opportunity to buy a share for 0,0007$ while its market
value is of the shares in 1989 is : 23709000 / 4719569 = 5,0235.
(total equity / number of shares ). Plus, as the end of 1989, 152279 warrants were
already vested.

b. If Pinkerton does not pay down the Berkeley debt within five years (and does not
go ahead with the IPO), what will be the number of shares outstanding as of January
1, 1994?

As in 1989, already has 4719569. Berkley are allowed to get 507597 and already
vested 152279. They will vest all of them, so (507597-152279 = 355318)
In 1994, there will be 4719569 + 355318 = 5,074,887 shares.

c. If Berkeley uses its warrants, how does this affect Pinkertons other shareholders
in qualitative terms?

There will be more shares, thus the value of the shares will decrease by a lot.
Therefore, other shareholders will lose money if Berkley uses it warrants.


3.
a) Calculate Pinkertons asset cost of capital. Assume that the beta given for
Wackenhut is the firms equity beta and that the market risk premium (E(rm) rf) is
6%.
B = 1,3
Rm-rf = 6%
Rf = 10,5 %

10,5 + 1,3 ( 6 ) = 18,30%


Estimate Pinkertons free cash flows between 1990 and 1999. To do this,
use the financial assumptions on page 5. Your valuation should also assume
that (a) the corporate tax rate is 37%; (b) the growth rates Pinkerton is using
are nominal rates (i.e. not inflation adjusted); (c) the valuation date is
December 31, 1989. Dont forget to deduct depreciation and (tax deductible)
amortization before you arrive at EBIT. Page 5 and footnote 4 details
depreciation, tax deductible amortization and non-tax deductible
amortization.