Need help. Setting up new gear set 742 case

You need more shim between the pinion bearings. I wouldnt change the shim between the pinion and inner bearing yet, untill you run a pattern.

It has been a few years since i set one up but from recollection I would not torque the pinion nut untill you have finished setting the pattern up with shim between the pinion and inner bearing. After this you shim between the bearings and torque the nut, adding or removing shim till you get the right drag torque for the pinion rotation. After all this do a final check of backlash and pattern.