raising debt vs. equity

Winfield Refuse Management Inc.

Raising Debt vs. EquityIris ChenAlex Ho

Brian HuangPramod Jindal

Michael Trecroce

Winfield Refuse Management 2

Executive Summary

Objective

Alternatives

Recommendation

Criteria

What is the best financing option for the $125M acquisition of Mott-Pliese Integrated Solutions (MPIS)?

1. Debt with Fixed Principal Repayments2. Debt3. Equity4. Debt & Equity

Winfield should finance the $125M through issue of bonds with no principal repayments

Impact on Firm:• Total Cost of Financing (NPV)Impact on Shareholders:• EPS & ROERisk Tolerance:• Interest coverage, Debt coverage, Dividend coverage


Introduction

Winfield MPIS

Winfield + MPIS

$27M $15M $42M

Midwest Mid-Atlantic & Midwest

Midwest & Mid-Atlantic

+ =

Net Income Net Income Net Income

Region Region Region


Winfield’s Current Financial Position

50%50%

Industry: Debt-to-Equity

Equity Debt

79%

21%

Winfield: 100% Equity Ownership

Winfield Family OTC

2006 2007 2008 2009 2010 2011 2012E$0.00

$0.50

$1.00

$1.50

$2.00

EPS and DividendsDPS

$/S

hare

2006 2007 2008 2009 2010 2011 2012E

$0

$100

$200

$300

$400

$500

$0

$10

$20

$30

$40

$50

Winfield’s Revenue and Net IncomeRevenue

Reven

ue (

$M

)

Net

Inco

me (

$M

)


Financing Alternatives

1. Debt with Fixed Principal Repayments 15 years 6.5% interest rate $6.25M annual principal

payment

Capital Needs: $125M

2. Debt 15 years 6.5% interest rate Full principal paid at Year 15

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

05

1015202530354045

8.132.44

6.25

6.25

37.50

Debt with Fixed Principal Repayment ScheduleInterest

Year

Cash

Ou

tflo

ws

($M

)

0

20

40

60

80

100

120

140

8.13

125.00 Debt Schedule

Interest

Year

Cash

Ou

tflow

s (

$M

)


Financing Alternatives Continued:

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

0

20

40

60

80

100

120

140

160

180

7.50

Dividend Payout ScheduleDividend

Year

Cash

Ou

tflo

ws

($M

)

0

20

40

60

80

100

120

140

160

Interest: 6.09Dividend: 1.87

Principal: 93.75

Debt (75%) and Equity (25%) ScheduleInterest Principal Dividend

Year

Cash

Ou

tflo

ws

($M

)

3. Equity 7.5M new shares @ $17.75 Perpetual Dividend Payments Dividend Policy is $1.00/Share

Capital Needs: $125M

4. Debt & Equity 25% equity, 75% debt 1.87M new shares @ $17.75 Perpetual Dividend Payments Dividend Policy is $1.00/Share


Decision Criteria

Impact on Firm:• Total Cost of Financing (NPV)

Impact on Shareholders:• Earnings Per Share• Return on Equity

Risk Tolerance:• Interest coverage• Debt coverage• Dividend coverage


Cost of Financing (NPV)1

Among all the financing options considered, Debt (with no principal repayments) has the lowest NPV cost whereas Equity has the highest

NPV cost. 1NPV mentioned here represents the cost of financing cost and the lower NPV implies cheaper financing2Cost of Equity was calculated using CAPM formula3Cost of Debt of 3.5% (Prime in 2012) was used rather than Initial Cost of Debt (i.e., 6.5% in 2012)

Debt with Fixed

Principal Repay-ments

Debt Equity 75% Debt + 25% Equity

$0

$20

$40

$60

$80

$100

$120

$140

$160

$113 $107

$145

$117

NPV of Financing Alternatives

NP

V o

f Fnanci

ng C

osts

($M

)

Assumptions

Marginal Tax Rate 35%Beta 0.36 Market Risk Premium 6%Risk-free Rate (Rf) 3%Cost of Equity2 (Ke) 5%Cost of Debt3 (Kd) 3.5%Time horizon (Years) 15Dividend per share $1


Debt Equity

Pros No impact on shares No impact on earnings

Cons Reduced earnings by interest

Increased number of shares

Expected EPS

$ 2.51 $1.91

Earnings Per SharePre-acquisition EPS: $1.83

$46

.00

$48

.00

$50

.00

$52

.00

$54

.00

$56

.00

$58

.00

$60

.00

$62

.00

$64

.00

$66

.00

$68

.00

$70

.00

$72

.00

$74

.00

$76

.00

$78

.00

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50Post-acquisition Earnings Per Share

EPS (Debt)

EPS(Equity)

EPS (Debt+Equity)

EBIT ($M)

Earn

ing

s P

er

Sh

are

Expected EBIT of 66M

Debt financing options provide the highest expected EPS under likely EBIT scenarios.


• Adjusted EPS = (NI-principal repayment)/ number of shares

• Higher earnings per share with the bond option, even treating principal repayments as “expenses”

Adjusted Earnings Per Share

$46

.00

$48

.00

$50

.00

$52

.00

$54

.00

$56

.00

$58

.00

$60

.00

$62

.00

$64

.00

$66

.00

$68

.00

$70

.00

$72

.00

$74

.00

$76

.00

$78

.00

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

Adjusted Post-acquisition EPS

EPS( Debt, including principal repayment)EPS(Equity)

EBIT ($M)

Adju

ste

d E

arn

ings P

er

Share


Even with Principal Repayments included on an Adjusted EPS basis, EPS with Debt Financing would be greater than EPS with Equity Financing


Return of Equity

Debt Equity

Pros No impact on shares No impact on earnings

Cons Reduced earnings by interest

Increased BV of equity

Expected ROE

5.80% 5.25%

Pre-acquisition ROE: 4.01%

$46

.00

$48

.00

$50

.00

$52

.00

$54

.00

$56

.00

$58

.00

$60

.00

$62

.00

$64

.00

$66

.00

$68

.00

$70

.00

$72

.00

$74

.00

$76

.00

$78

.00

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

Post-acquisition ROE

ROE (Debt+Equity)ROE(Equity) ROE (Debt)

EBIT ($M)

Retu

rn o

n E

qu

ity (

%)


Debt financing options provide the highest expect ROE under likely EBIT scenarios.


From Monte-Carlo Simulation (See Appendix):• EBIT for any given year can range from $46M to $78M• Retained earnings by FY2026 can range from $693M to $1,073M

1Debt service includes interest and principal repayment except for the bullet year2Debt retirement refers to ability to pay back the principal by end of the term

Debt Service and Retirement Coverage

46 48 50 52 54 56 58 601x3x5x7x9x

11x13x15x17x19x21x

Debt Service Coverage

Debt with Fixed Principal Re-paymentDebt75% Debt and 25% Equity

Combined Estimated EBIT (in $M)

693 726 759 792 825 8582x

7x

12x

17x

22x

27xDebt Retirement Coverage

Debt with Fixed Principal Repayment DebtEstimated Retained Earnings by 2026 (in $M)

Winfield can safely meet debt obligations under all financing alternatives.


Dividend Payout CoverageAssuming Winfield continues to pay $1 dividend per share to all of its shareholders in each financing option:

1Dividend to 15M existing shareholders plus additional shareholders needed for the respective option.

46 48 50 52 54 56 58 601x

2x

3x

Dividend Payout Coverage Ratio1

Debt with Fixed Principal Repayment EquityDebt 75% Debt and 25% Equity

Combined EBIT for any given year

Winfield can safely pay dividends to shareholders under all financing alternatives


• Other considerations By issuing debt, Winfield would avoid control

dilution Flexibilities – sufficient cash flow to meet

commitments under all options

Decision Criteria Debt

Debt with Principal Repayme

nt

Equity

Debt (75%) + Equity (25%)

Cost of Financing (NPV)

Expected EPS

Expected ROE

Risk Tolerance (Coverage)represents the better alternative represents the lesser alternative

Winfield should finance the $125M through issue of bonds with no principal repayments

Evaluation of Options & Summary

Question & Answers

Thank you for listening to our presentation!


Concerns from Last Board DiscussionConcern Our View

Andrea Winfield Stock issue is lower cost and additional debt would increase risk leading to swings in stock price

Stock issue is most expensive option. Winfield can meet debt obligations under varying EBIT scenarios. In fact, debt will increase EPS and ROE, increasing stock price.

Joseph Winfield By issuing 7.5M shares, Winfield will only have to pay $7.5M in dividends

Debt cash outflows with debt is for a finite period while stock dividend outflows are perpetual

Ted Kale Market price is too low (based on Price-to-book comparable). Issuing shares at low price and loss of management control is a disservice to current stockholders.

This is not the only criteria for financing. Price may be low due to a liquidity discount to trade OTC. P/B is not comparable when capital structure varies.

Joseph Tendi Principal repayment obligation is irrelevant to the financing decision

Principal repayment is relevant because it is a real cash outflow

James Gitanga Other major companies have long-term debt in capital structure while Winfield is unusual

Analysis shows Winfield has the capacity to take-on more debt in its capital structure.

Appendix

Winfield Refuse Management Inc.


Summary of Financing Schedules


Monte-Carlo Simulation: Estimated Combined EBIT

Note: Standard Deviation was calculated from last 5 year performance.

Std Dev AverageMIPS Before Tax 2,377 24,000 Winfield Before Tax 3,639 36,745


Monte-Carlo Simulation: Estimated Retained Earnings in FY 2026

Note: Ending Retained Earnings= Beginning Retained Earnings + Net Income – DividendNet Income Standard Deviation=3.6


Cash outflows for debt optionsDebt with fixed principal repayments: Financing Cash Flow ($M)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026Debt 125.0 118.8 112.5 106.3 100.0 93.8 87.5 81.3 75.0 68.8 62.5 56.3 50.0 43.8 37.5 Principal Repayments 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 37.50 Interest 4.38 4.16 3.94 3.72 3.50 3.28 3.06 2.84 2.63 2.41 2.19 1.97 1.75 1.53 1.31 Debt Outstanding 118.75 112.50 106.25 100.00 93.75 87.50 81.25 75.00 68.75 62.50 56.25 50.00 43.75 37.50 -

Tax shield 1.53 1.45 1.38 1.30 1.23 1.15 1.07 1.00 0.92 0.84 0.77 0.69 0.61 0.54 0.46 Interest Payment after tax 2.84 2.70 2.56 2.42 2.28 2.13 1.99 1.85 1.71 1.56 1.42 1.28 1.14 1.00 0.85 Principal Repayments 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 37.50 Net Cash Outflow 9.09 8.95 8.81 8.67 8.53 8.38 8.24 8.10 7.96 7.81 7.67 7.53 7.39 7.25 38.35 NPV 113

Debt: Financing Cash Flow ($M)2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

Debt 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 Principal Repayments - - - - - - - - - - - - - - 125.0 Interest 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 Debt Outstanding 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 -

Tax shield 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 Interest Payment after tax 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 Principal Repayments - - - - - - - - - - - - - - 125 Net Cash Outflow 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 127.8 NPV 107


Cash outflows for Equity optionsEquity: Financing Cash Flow ($M)2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

Dividend Payout 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 TV 145 Div+TV 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 153 NPV 145

Equity and Debt: Financing Cash Flow ($M)2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

Debt 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 Principal Repayments - - - - - - - - - - - - - - 94 Interest 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 Debt Outstanding 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 93.8 -

Tax shield 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 Interest Payment after tax 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 Principal Repayments - - - - - - - - - - - - - - 94 Net Cash Outflow 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 95.9 NPV of Debt 81


Cost of Financing (3.5% vs. 6.5%)

Debt with fixed

principal repay-ment


$0

$20

$40

$60

$80

$100

$120

$140

$160

$106$98

$145

$110


NP

V o

f Fnanci

ng C

osts

($M

)Debt with

Fixed Principal Repay-ments


$0

$20

$40

$60

$80

$100

$120

$140

$160

$113 $107

$145

$117


NP

V o

f Fnanci

ng C

osts

($M

)

NPV @ 3.5% NPV @ 6.5%

Change in Interest from 3.5% to 6.5% yields the same financing decision.


EPS (with interest = 6.5%)

$46

.00

$48

.00

$50

.00

$52

.00

$54

.00

$56

.00

$58

.00

$60

.00

$62

.00

$64

.00

$66

.00

$68

.00

$70

.00

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Post-acquisition EPS

EPS (Debt)

EPS(Equity)

EPS (Debt+Equity)


EBIT ($M)


Adjusted EPS (with interest = 6.5%)

$46

.00

$47

.00

$48

.00

$49

.00

$50

.00

$51

.00

$52

.00

$53

.00

$54

.00

$55

.00

$56

.00

$57

.00

$58

.00

$59

.00

$60

.00

$61

.00

$62

.00

$63

.00

$64

.00

$65

.00

$66

.00

$67

.00

$68

.00

$69

.00

$70

.00

$71

.00

-

0.50

1.00

1.50

2.00

2.50

3.00

Adjusted Post-acquisition EPS

EPS( Debt, including principal repay-ment)

EPS(Equity)



ROE (with interest = 6.5%)

$46

.00

$48

.00

$50

.00

$52

.00

$54

.00

$56

.00

$58

.00

$60

.00

$62

.00

$64

.00

$66

.00

$68

.00

$70

.00

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

Post-acquisition ROE

ROE (Debt+Equity)

ROE(Equity)

ROE (Debt)


raising debt vs. equity

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