Financial Management Assignment

Pre-read Assignment-2
of
Winfield Refuse Management, Inc.: Raising Debt vs. Equity

Submitted to

Prof. Kanagaraj Ayyalusamy

Submitted by

Section – A
Ankit Guleria (BJ22009), Mohit Singh (BJ22024), Nitish Bajaj (BJ22027), Rahul Jain (BJ22034)

Date

09/01/2023

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 WINFIELD REFUSE MANAGEMENT
Case Brief:

Winfield Refuse Management is a US-based non-hazardous waste management company. Currently, it

caters to nearly half-million industrial, commercial, and residential customers in nine US states. It has
always followed the approach of avoiding long-term debts. As of 2012, its capital structure consists of
common stock with 79% held by the Winfield family & management.

The waste management industry is highly fragmented with national, public, and regional operators.
Bigger companies benefitted from economies of scale. Despite the slower growth than overall GDP due
to declining waste per capita (because of increased sustainability initiatives), businesses in this industry
generated very steady cash flows.

In 2010, Winfield engaged in larger acquisitions from its conventional small ‘tuck-in’ acquisitions to
maintain its competitive position in Midwest. In 2011, it decided to acquire Mott-Pliese Integrated
Solutions (MPIS) to improve its cost position in Midwest and enter the mid-Atlantic market. Both entities
have settled on an acquisition price of $125 mn. As a CFO of Winfield, Mamie Sheene, needs to assess
the available alternatives of debt and equity financing to raise the acquisition amount.

Issue of the case/Problem statement:

The board needs to decide on the appropriate financing option (debt or equity) to raise the acquisition
amount such that the shareholder’s value is maintained, and the cost of financing is minimized.

Type of Financing Proposal Arguments against the proposal

Equity Investment bank: Ted Kale:
Issuing 7.5 mn new common stocks at $16.67 Undervalued shares;
per share (after considering underwriting fees) competitors have higher price-
equity ratio

Debt Sheene: Andrea:

Selling bonds @6.5% p.a. with annual Debt burden will increase risk
repayments of $6.25 mn for 15 yrs and leading to high volatility of stock
outstanding maturity amount of $37.5 mn prices

Debt Sheene: Joseph:

Selling bonds with single repayment plan after MPIS can generate over $15 mn
15 yrs. at @6.5% p.a. p.a. after taxes. EPS of $1 for
7.5mn shares = $7.5 mn; MPIS
clearly pays for itself; Bond issue
is not a good idea.
Other concerns Not to dilute stock’s value
Other players rely on long-term debt→ Winfield should also think on debt financing

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Alternatives:

• 100% Debt Financing – Under this option, Winfield can either issue bonds or take a loan for $125
million. This can be done in two ways.
o As mentioned in the case, Winfield can pay interest at the rate of 6.5% along with $6.5
million as annual repayment for 15 years with $37.5 million paid at maturity.
o Debt of $125 million to be paid in a single repayment plan at the end of 15 years with
annual interest payments at rate of 6.5%.
• 100% Equity Financing – Winfield can issue shares at a price of $17.75, which after considering
underwriting fees come down to $16.67. At this price, the company has to issue 7.5 million new
shares to finance the acquisition of MPIS worth $125 million.
• Mix of debt and equity – Winfield can raise the funds with an appropriate combination
percentage of debt and equity financing to finance the $125 million acquisition.

Criteria & Evaluation of Alternatives:

I. Cost of financing: In this criterion, the alternatives will be looked upon in their cost of financing
in the case of a debt, the bond is issued at 6.5% but the interest paid on the bond is tax
deductible and the tax rate is 35% according to the case so effective cost of debt is 4.225%. In
the case of equity, shares are issued at $16.67 effectively and we assumed a dividend of $1
which is maintained by the company in the past 3 years and is expected to continue in the
future. According to these numbers, the cost of equity comes out to be 6% which is greater than
the cost of debt. So, using this criterion, we can say that debt is better than equity.
II. Impact on EPS: The impact on EPS in both options has been shown in the table below. In the
case of debt financing, the EPS could increase up to $2.51, which is a better option for the
existing shareholders even after a repayment obligation of $0.42 per share for a period of 15
years. However, equity financing would only increase the EPS to $1.91, which is inferior to debt
financing.

Impact on EPS
Particulars Bonds Stock
EBIT 66 66
Interest, 1st year 8.125 0
EBT 57.875 66
Tax @ 35% 20.2563 23.1000
PAT 37.6188 42.9000

Shares O/S 15 22.5

EPS 2.51 1.91

Annual Principal Repayments 6250 0

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 III. Cash Burden: In the case of debt the company projects to pay $6.25 million as annual principal
repayment plus interest for every year so the cash burden in the first year is $14.4 million. It
goes on reducing year by year and in the last year, it would rise as we must repay outstanding
principal equal to $37.5 million. In the case of equity, the cash burden on the company is $7.5
million and it goes on till perpetuity. So, in debt financing, we can say that though the cash
burden is higher in the shorter run, in the long term it will reduce, ultimately leading to no cash
burden. However, in the case of equity, the cash burden goes on forever. Therefore, we can
conclude that debt is better than equity in the long term.
IV. Impact on shareholders(P/E): One of the deterrents to equity financing is the issuance of new
shares at a price of 17.75 which is at a lower P/E ratio than the industry average and therefore,
the existing shareholders are at a disadvantage.

Conclusion:

Based on the evaluation of alternatives using the criteria listed above, we have concluded that debt
financing is better than equity financing.

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