Winfield Refuse Management, Inc.

Raising Debt vs. Equity

Summary of the Winfield Refuse Management Acquisition Dilemma:
Winfield Refuse Management, Inc. is a Non-Hazardous waste management company. The company
was founded by Thomas Winfield but is now managed professionally, with the board having a few seats for
the Winfield family. Since its inception, the company has followed a policy of avoiding long-term debt.
The company primarily focused on Organic growth in its early stages. However, several small acquisitions
have benefited the company mid and later stages. The company is looking to acquire another company:
Mott-Pliese Integrated Solutions (MPIS), for its geographical expansion into the mid-Atlantic region. This
acquisition was significantly large for Winfield Inc. at $125 million. MPIS would accept up to 25% of the
purchase price in Winfield stock. The board of Winfield has agreed and given a go for acquiring MPIS, but
the mode of raising funds has brought the firm into a dilemma. The board has segmented views into
multiple options with many pros and cons. The board is divided into the possibilities of raising funds via
debt, equity, or a mix of both.
Debt is being considered by issuing long-term bonds to Massachusetts Insurance Company at an annual
interest rate of 6.5% with 15 years of maturity. If the company goes with this option, it would have a cash
outflow of $6.25 million as annual principal repayment. At maturity of 15 years, another outflow of $37.5
million would be necessary. With the current marginal tax rate of 35%, a tax shield would benefit the
company resulting in an effective interest rate of 4.225%.
If the company goes for stock issuance at a rate of $17.5 per share, it could raise $16.67 per share after
deductions. This would require them to issue a total of 7.5 million shares. On payment of $1 per share as a
dividend, the company would incur an annual cost of 6% (calculated at $16.67 per share).

Problems for the company in this acquisition:

Raising funds, either way, came with its own set of concerns. The family of Winfield had concerns
about increasing long-term debts by issuing bonds. Others were primarily concerned about lowering share
value for existing shareholders to benefit the new one by giving equity. Some also argued that this need
not just be decided on any factor but weighed by Earning Per Share.
Andrea Winfield, one of the board members from the Winfield family, is concerned about the
additional $6.25 million per year as principal repayment since she is considering that the company already
has a significant amount of long-term debt.
Observations: Andrea needs to consider that stock issuance comes at a higher cost than debt. The cost of
debt is less than the cost of equity, which reduces the overall Cost of Capital and results in higher
enterprise value and, therefore, the higher intrinsic value of the share.
 Andrea’s uncle, Joseph Winfield, also supports equity issuance over bond issuance. As per him, the
additional 7.5 million shares will result in an additional cash outflow of $7.5 million per year (considering
the current rate of $1 dividend per share), which in his regard, is less than the annual cash outflow from
bond issuance.
Observations: He needs to consider that the dividend will be paid for perpetuity, while for the debt, the
outflow will be only for 15 years.
Ted Kale, a director, is against equity issuance. He already thinks that the Winfield shares are
undervalued, and by the new allocation of stocks, it would be unjust to the current shareholders to issue
fresh stock. He argues that the issuance will be a gift to the new shareholders at the expense of the old
ones.
Observations: While Ted is correct that the fresh share issuance will reduce the shareholding of the existing
shareholders, the share price does not always reflect the firm's actual value.
Joesph Tendi and Naomi Ghonche, the other two directors, are concerned about the dilution of
Earning per share post-stock issuance. They believe that the EPS will increase if the path of debt is chosen
over stocks.
Observations: They are right about the facts but should also consider the NPV and the EPS.

Alternate Solutions for the issue(s):

We have considered the NPV approach to finding the Net Cash Outflow of the firm. To achieve this, we
have considered the following four scenarios:
Scenario 1: The company issues bonds of $125 million at an interest rate of 6.5% annually for 15 years with
annual principal repayment of 5% of the issue, i.e., $6.25 million.
We have considered a discounting rate of 6.5% (the same as the interest rate for debt). The tax rate has
been taken as 35% (per the case).
Based on our calculations, we found that the NPV for Scenario 1 is $106.07 million.

Scenario 1: Debt of $125 million with Annual Principal repayment of $6.25 million
Yea Principal Interest Principal Net Cash Principal Present
r O/S Interest (1-tax) repaid outflow O/S Value
1 125.00 8.13 5.28 6.25 11.53 118.75 10.83
2 118.75 7.72 5.02 6.25 11.27 112.50 9.93
3 112.50 7.31 4.75 6.25 11.00 106.25 9.11
4 106.25 6.91 4.49 6.25 10.74 100.00 8.35
5 100.00 6.50 4.23 6.25 10.48 93.75 7.65
6 93.75 6.09 3.96 6.25 10.21 87.50 7.00
7 87.50 5.69 3.70 6.25 9.95 81.25 6.40
8 81.25 5.28 3.43 6.25 9.68 75.00 5.85
9 75.00 4.88 3.17 6.25 9.42 68.75 5.34
10 68.75 4.47 2.90 6.25 9.15 62.50 4.88
11 62.50 4.06 2.64 6.25 8.89 56.25 4.45
12 56.25 3.66 2.38 6.25 8.63 50.00 4.05
13 50.00 3.25 2.11 6.25 8.36 43.75 3.69
14 43.75 2.84 1.85 6.25 8.10 37.50 3.35
15 37.50 2.44 1.58 37.50 39.08 0.00 15.20
NPV 106.07
Scenario 2: The company issues bonds of $125 million at an interest rate of 6.5% annually for 15 years,
with the entire principal paid at maturity.
We have considered a discounting rate of 6.5% (the same as the interest rate for debt). The tax rate has
been taken as 35% (per the case).
Based on our calculations, we found that the NPV for Scenario 1 is $98.26 million.

Scenario 2: Debt of $125 million with principal repayment at maturity

Principal Interest Principal Net Cash
Year O/S Interest (1-tax) repaid outflow Present Value
1 125 8.13 5.28 5.28 4.96
2 125 8.13 5.28 5.28 4.66
3 125 8.13 5.28 5.28 4.37
4 125 8.13 5.28 5.28 4.11
5 125 8.13 5.28 5.28 3.85
6 125 8.13 5.28 5.28 3.62
7 125 8.13 5.28 5.28 3.40
8 125 8.13 5.28 5.28 3.19
9 125 8.13 5.28 5.28 3.00
10 125 8.13 5.28 5.28 2.81
11 125 8.13 5.28 5.28 2.64
12 125 8.13 5.28 5.28 2.48
13 125 8.13 5.28 5.28 2.33
14 125 8.13 5.28 5.28 2.19
15 125 8.13 5.28 125 130.28 50.66
NPV 98.26

Scenario 3: The company issues 7.5 million shares worth $125 million for $17.5 per share. The company
pays a constant annual dividend of $1 per share.
In this scenario, we are considering an additional outflow of $7.5 million per year (considering a $1 annual
dividend per share). Discounting this at 6.5% (the same as the interest rate for debt), we found that the
NPV is $115.38 million for perpetual dividend pay (calculated as $7.5 million / 6.5%).
Scenario 4: As MPIS has shown interest in accepting up to 25% of the purchase price in stocks, the
company issues common stock worth $31.25 million to MPIS (1.875 million shares).
Case 4a: The company also issues bonds worth $93.75 million at an interest rate of 6.5% annually for 15
years with annual principal repayment of 5% of the issue.

Scenario 4a: Debt of $93.75 million with Annual Principal repayment of $4.69 million
Yea Principal Interest Principal Net Cash Principal Present
r O/S Interest (1-tax) repaid outflow O/S Value
1 93.75 6.09 3.96 4.69 8.65 89.06 8.12
2 89.06 5.79 3.76 4.69 8.45 84.38 7.45
3 84.38 5.48 3.56 4.69 8.25 79.69 6.83
4 79.69 5.18 3.37 4.69 8.05 75.00 6.26
5 75.00 4.88 3.17 4.69 7.86 70.31 5.73
 6 70.31 4.57 2.97 4.69 7.66 65.63 5.25
7 65.63 4.27 2.77 4.69 7.46 60.94 4.80
8 60.94 3.96 2.57 4.69 7.26 56.25 4.39
9 56.25 3.66 2.38 4.69 7.06 51.56 4.01
10 51.56 3.35 2.18 4.69 6.87 46.88 3.66
11 46.88 3.05 1.98 4.69 6.67 42.19 3.34
12 42.19 2.74 1.78 4.69 6.47 37.50 3.04
13 37.50 2.44 1.58 4.69 6.27 32.81 2.77
14 32.81 2.13 1.39 4.69 6.07 28.13 2.52
15 28.13 1.83 1.19 28.13 29.31 0.00 11.40
NPV 79.55
For the equity issued to MPIS, we are considering an additional outflow of $1.875 million per year
(considering a $1 annual dividend per share). Discounting this at 6.5% (the same as the interest rate for
debt), we found that the NPV is $28.85 million for perpetual dividend pay (calculated as $1.875 million /
6.5%).
Thus, the total NPV is $108.4 million.
Case 4b: The company also issues bonds worth $93.75 million at an interest rate of 6.5% annually for 15
years, with the entire principal repaid at maturity.

Scenario 4b: Debt of $93.75 with Principal repayment at maturity

Principal Interest Principal Net Cash Present
Year O/S Interest (1-tax) repaid outflow Value
1 93.75 6.09 3.96 3.96 3.72
2 93.75 6.09 3.96 3.96 3.49
3 93.75 6.09 3.96 3.96 3.28
4 93.75 6.09 3.96 3.96 3.08
5 93.75 6.09 3.96 3.96 2.89
6 93.75 6.09 3.96 3.96 2.71
7 93.75 6.09 3.96 3.96 2.55
8 93.75 6.09 3.96 3.96 2.39
9 93.75 6.09 3.96 3.96 2.25
10 93.75 6.09 3.96 3.96 2.11
11 93.75 6.09 3.96 3.96 1.98
12 93.75 6.09 3.96 3.96 1.86
13 93.75 6.09 3.96 3.96 1.75
14 93.75 6.09 3.96 3.96 1.64
15 93.75 6.09 3.96 93.75 97.71 37.99
NPV 73.70

For the equity issued to MPIS, we are considering an additional outflow of $1.875 million per year
(considering a $1 annual dividend per share). Discounting this at 6.5% (the same as the interest rate for
debt), we found that the NPV is $28.85 million for perpetual dividend pay (calculated as $1.875 million /
6.5%).
Thus, the total NPV is $102.55 million.

Concluded Solution:
We, after thorough consideration, suggest the Winfield company raise the entire $125 million worth of
funds through issuing Bonds, i.e., by Debt. Instead of an annual repayment of $6.25 million, they pay the
total principal at maturity.
The overall cost of capital is very low with this option. Also, as suggested in the case, when EBIT is above
$24.35 million, the Debt option will have a higher EPS than the Stock issuance option.

Thank you.