Ojas Gupta

BUSI 710: Financial reporting and analysis

Professor: Thomas Nickles
Case study 4:

“Winfield Refuge management: Raising Debt Vs Equity”

To Ms. Mamie Sheen,

Firstly, I would like to express my appreciation for the opportunity to serve you in evaluating
the financial options for “Winfield Refuge management”. As per the brief analysis of the current
situation and the board discussion provided by you including the financial statement, EBIT chart
and balance sheet, I am confident that my recommendations would be able to help you in
choosing the right course of action and presenting to the bard in the next meeting.
According to the report submitted I would be covering two major points in my analysis:
1. My recommendation of what would be the appropriate financial structure for investment
decision- raising capital through Debt Vs Equity.
2. Cash flow analysis to present in front of the board that would help in minimising
objections and explaining the path chosen

Case introduction and summery of the meeting:

Winfield refuge management, is a vertically integrated, non-hazardous waste management
company that is expanding their business by planning a major acquisition of MPIS (Mott-Pliese
Integrated Solution). The acquisition of MPIS was followed along with a major financial decision
of whether to finance it through Debt or Equity.

Winfield started in 1971 as a two truck operation in Creve Coeur, Missouri and by 2012; it had
acquired 22 landfills and 26 transfer stations with served 33 collection operations. The board of
the company had always adhered to a consistent policy of avoiding long term debts. Since the
1990 the company was working by generating steady cash flow and raising equity whenever
required along with making small acquisitions that would extend their geographical reach. As the
current working of the company was in mid-west, with the competitions indulging in
consolidating strategies, to sustain in the competitive market and maintain its position the only
option for them was acquisition.

MPIS assets were not a strategic fit with any other acquirer but it served parts of Ohio, Indiana,
Tennessee, and Pennsylvania and acquiring such a firm would increase Winfield’s footprint along
with cost position. MPIS has a strong management producing 12-13% operating margins every
year and the acquisition bid was $125 million and was also ready to accept 25% of purchase price
in Winfield stock. As written in your report in an earlier meeting with the board of directors, they
refuse to fund this opportunity with long term debts to stand still with their beliefs of not acquiring
debts. Furthermore, a few board members also suggested to look into financing $125m through
equity that is releasing 7.5 Million shares at $17.68 as they analysed it to be beneficial. As you being
the chef financing officer and analysing your numbers you suggested that financing through debt
would be the best step forward. Keeping the conversations in mind in this letter I would be analysing
with financial option would be better for the company and would also be providing with some
plausible explanations that you can give to the board members.

Existing fact and figures (Including board discussion)

The industry is highly fragmented, with a few national, publically traded players such as Water
management Inc. and republic services competing against regional operators. The waste
management market is growing slower than the overall GDP, due to increase in recycling and
composting. However, this market produced steady cash flow, and was recession proof along
with predictable demand. All the companies in the pertaining sector was thriving to achieve their
highs and acquisition spree is touching highs in the business. Following this spree, Winfield
being a regional operator wanted to stand along with the competition through acquiring MPIS.
Acquisition costed $125 million, which required external financing. With this need came along
deciding on certain financial options. Opting for Equity, it was estimated that a common stock
could be issued at $17.75 per share and net proceeds to Winfield would be $16.67 per Share. 7.5
million shares would be required for MPIS. Though the company’s performance has been steady
and has been paying its dividends regularly, but since the last 2 – 3 years its performance has
been disappointing.
If the firms Decides to go for bonds, it could sell $125 million in bonds at 6.5% annual interest
rate maturing at 15 years to a Massachusetts insurance company. Annual principal payment
would be required, leaving $37.5 Million at maturity. Furthermore, as you suggested the interest
rate is tax deductible and the 6.5% interest rate would be equivalent to 4.225 % on after tax basis
and would be the most economical. However, in the board meeting there were some agreements
and some question on this options as this might lead the firm to some financial risk and lead to
wild swing in the stock prices.
While going ahead with equity it would dilute the earning per share to $1.91, and with debt it
would rise to $2.51. The combined EBIT of Winfield and MPIS came out to $66million.
In the following section these cases would be analysed along with some recommendation and
possible solutions.
 Case Analysis
As per the report given I have analyzed 3 cases
1. Financing through debt with fixed repayments and 6.5% interest
2. Financing entirely through Debts
3. Financing entirely through equity
ROE (return on equity prior to acquisition) = Net income in 2011(26,350,000)/average
stockholder equity (685380) = 3.84%

1. Financing through debt with fixed repayments and 6.5% interest on principal
amount

Figure 1: Reflects the calculation of NPV when financing through debt with fixed payment of $6.25 Million and interest
(Refer to Excel File attached for important notes)

In the current case the entire capital is financed through incurring debt with fixed principal
payment of $6.5 million with and interest rate of 6.5%. The remaining of $37.5 million at
maturity. The first year interest payment accounts to $8.5 million and decrease thereafter as the
principal decreases after paying the interest of 6.5 %. As the interest payment is tax deductible
the net interest paid comes out to be $5.28 million (after tax interest is 4.225 %) for the first year
and similarly for the next years. The net present value of financing though debt with fixed
repayment and interest comes out to be $106.78 million.

 Interest at 6.5%= 125 x 6.5% = $ 8.125 Million

 Interest payment after tax = Total Loan amount x after tax interest = 125 x [ 0.065(1-
0.35)] =$ 5.281 million
 Net cash outflow is sum of net interest payment after tax and principal repayment
 NVP is the sum of discounted cash flow = $106.78 million
 Finance through Debt and fixed payment of $6.25
45
million with 6.5%interest an principal
40
1.58
35
Cash Outflow (M$) 30
25
20 37.5
15
10 5.28 5.01 4.75 4.48 4.22 3.96 3.69 3.43 3.17 2.90 2.64 2.37
2.11 1.85
5
6.25 6.25 6.25 6.25 6.25 6.25 6.25 6.25 6.25 6.25 6.25 6.25 6.25 6.25
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Years
Net interest Paid Principle payment

Figure 2: Graphical Representation of the financial case

2. Financing entirely through Debt with 6.5% interest

Figure 3:: Reflects the calculation of NPV when financing through debt 6.5% interest
(Refer to Excel File attached for important notes)

In this case the entire capital is financed through Debt with an interest payment of 6.5% and the
principal amount on maturity. The yearly interest payment comes out to be $8.5 million (6.5% of
$125 million) before tax. As the tax is deductible on the interest payment the net interest
payment comes out to be $5.28 million (after tax interest is 4.225 %). The NPV (net present
value) comes out to be $98.30 Million that means the cost of financing the debt.
Also the earning per share after acquisition with EBIT of $66 million is $2.51.

 Interest payment after tax = Total Loan amount x after tax interest = 125 x [ 0.065(1-
0.35)] =$ 5.281 million
 NVP is the sum of discounted cash flow = $ 98.30 million
 Finance Through Debt
140
Principle Paid ,
120 125
Cash Outflow(M$) 100

80

60

40

20 Net interest Paid

, 5.285
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Years
Principle Paid Net interest Paid

Figure 4: Graphical representation of the financial case

ROE (return on equity post to acquisition) = Net income /average stockholder equity
Net income = Net income of Winfield ($27 million) + Net income of MPIS ($15
million) = $42 million
Average stockholder equity = 685380 ROE= 6.12%
 3. Financing through Equity

Figure 5: Reflects the calculation of NPV when financing through equity

In this case if the company wants to acquire MPIS entirely through equity it needs to issues $7.5
million shares. As mentioned in the report the annual cash cost of stock issuance is 6% netting
$16.67 per share if the dividend of $1 is maintained my Winfield. Issuing 7.5 million shares at
dividend of $1 gives $7.5 million payment each year and the Maturity value given after 15 years.
There are some assumptions been taken with respect to the case, risk free return is assumed to
be 4%( past US data) along with the stock return in 2012 is assumed to be 13.4%. a lower
amount of beta has been used as the company’s dependency on market performance is minimal
(as mentioned above). In addition to this, the cost of equity upon calculation came out to be
6.80% (Risk-Free Rate of Return + Beta × (Market Rate of Return - Risk-Free Rate of Return)).
Furthermore, on calculation for the cost of financing for 15 years with the discount rate of
6.80% the NPV (Net present Value) is $ 125.30 million.

ROE (return on equity post to acquisition) = Net income /average stockholder equity
Net income = Net income of Winfield ($27 million) + Net income of MPIS ($15 million) = $42
million
Average stockholder equity = 685380+75000=760580
ROE= 5.52%
 NPV of Financial alternatives
$140.00

NOV of financial cost (M$)

$120.00

$100.00

$80.00

$60.00

$40.00

$20.00

$-
NPV( Debt with
NPV( Debt) NPV( Equity)
Fixed payment)
Series1 $106.78 $98.30 ₹ 125.30

Figure 6: Comparison of NPV of various financial options

Analyzing the above figure with eth NPV of financial options reflects the minimum cash flow
required to serve the debt. Computing the three options together the financial case of incurring
investment through debt requires the lease amount of cash that is $98 million in 15 years of
payment of debt. Financing through Equity would require the highest amount of cash flow to
service the debt. In terms of financing through debt the cash to be generated each year $5.28
million with the principal amount that is much less than dividend payment of $7.5 million each
year with maturity payment.

Figure 7: In this graph I would like to highlight the Earnings per share when the EBIT is $66million, financing through
debt the EPS is $2.51 while with equity it reduces it to $1.91

In the above figure I would want you to focus on earning per share row, prior to acquisition the
EPS was $0.70 with EBIT $24.35M. IF the company post acquisition, with EBIT $66 million,
plans to finances itself through Debt the EPS would increase to $2.51, which would have no
impact on shares (it will not dilute) and is higher than through equity. In addition to this if
financed though equity EPS would increase to $1.91 with no effect on earning and would also
dilute the shares leading to increase in number of shares and risking the existing shareholders as
well.
Recommendation and Proposed arguments
If the EBIT increase to $66 million as expected by the board members and as mentioned in the
report I would highly recommend the company to raise capital to acquire MPIS through Debts
without principal payments as it has higher ROE, EPS and the lowest NPV.
One of the weakness that the board members stated was increase in risk by incurring long term
debt that and the company already had some prior payment to me made. But the risk would also
be involved in raising capital through equity, as through equity it can harm the existing
shareholders and can reduce the share price of the company.
Moreover, the debt after 15 years would be gone, but if financed through equity the company
would be diluting itself and would also have to pay back dividends even after 15 years. Also, if
thought of repurchasing it would require shareholders consent.
Similarly, I have written some point that would help you in putting forward this recommendation
in front of the board members.

 Leveraging business through debt is a consistent way to build equity value for
shareholders as the debt principal is repaid.
 Interest of debt is tax deductible, making it most cost effective way of financing
 Debt can be a less expensive source of growth capital if the Company is growing at a
high rate.
 Risky investments since the company’s stocks are not doing well in the market it will be a
risky option
I hope my analysis would be helpful for you to put up a good financial case in front of the board
members in the next meeting.
Regards,
Ojas Gupta