Winfield Case

Winfield Refuse management, Inc. Raising Debt vs. Equity

Abhinandan Singh (MP15003)

Financial Management II

XLRI – PGDM 2015-18 Batch

Winfield Refuse Management, Inc. : Raising Debt vs. Equity Executive Summary: Winfield Reuse Management, a vertically integrated, non-hazardous waste management company is going for a major acquisition and has to take a decision whether to finance through Debt or Equity. The company started in 1972 as a two-truck operation in Creve Coeur, Missouri and by 2012; it had acquired 22 landfills and 26 transfer stations and material recovery facilities, which served 33 collection operations. Winfield’s board had adhered to a consistent policy of avoiding long term debt. The business was done through the steady cash flows and raising equity whenever required. Since early 1990’s the firm had been making small acquisitions by acquiring companies which would extend its geographical reach and creating economies of scale with existing facilities. Most of the company operation was in the Midwest and with other bigger companies indulging in consolidation strategy; it required to maintain a competitive position on a regional basis which was only possible through acquisition. Acquiring a firm like MPIS (Mott-Pliese Integrated Solutions), a waste management company serving parts of Ohio, Indiana, Tennessee, and Pennsylvania will increase their footprint in Midwest and also provide an entry into mid-Atlantic region. MPIS had a strong management team 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. At an earlier Board meeting most of the board members refused to accept the proposal of financing this deal through long term debt and suggested equity to be a better option to generate the revenue. As a chief financial officer Mamie Sheene was of the opinion that debt financing would be a better option and had to convince the Board members. In this case we have to analyze which financing option would be better for a company in terms of finance as well as strategy.

Important Facts and Figures Waste Management industry was highly fragmented and most of the players were private. All the companies in this sector aimed to achieve economies of scale and acquisition spree was going on in the business. Winfield being a regional player in Midwest region wanted to consolidate its position and also enter into other region. Acquisition cost was estimated to be $125 million 1 | Page

Financial Management II

XLRI – PGDM 2015-18 Batch

and was large enough which required external financing. 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. Company’s performance had been steady and the company reliably paid dividends but in last 2-3 years performance had been disappointing and dividend had not increased. If the firm goes for Bond, it could sell $125 million in bonds to a Massachusetts Insurance company. Annual interest rate would be 6.5% and would mature in 15 years. Annual principal repayments would be required, leaving $37.5 million outstanding at majority. When going for Equity it would dilute the EPS to $1.91, and debt would bump the EPS to $2.51. The EBIT for the combined Winfield –MPIS was expected to be $66 million.

Problem Statement   

What would be the appropriate financing structure for the investment decision-Raising capital through Debt or Equity? How the Debt or Equity decision would affect the shareholders and how EPS (Earnings per share) would be affected in both the cases. Should the firm goes for entire financing through debt or through Equity or a combination of both.

Return on Equity before taking this decision ROE = Net Income in 2011(26350) / Average Stockholder’s Equity (685380) = 3.84%

Possible Solutions A. Financing entirely through Debt with Interest payment and Final Principal Payment on Maturity

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Financial Management II

XLRI – PGDM 2015-18 Batch

Under this option the entire capital is to be financed through Debt with yearly interest payments and principal payment is done only on maturity. The yearly interest payment comes out to be $8.125 million with an interest rate of 6.5% on a principal of $125 million. As tax benefit will be reaped by the firm on interest payment so Net Interest Payment comes out to be 5.28 (65% of 8.125). The Net present value comes out to be $98.26 million at a discounting rate of 6.5%.

Earnings per Share - $2.51 B. Financing entirely through Debt with Fixed Principal payment of $6.25 Million and Interest payment on Present Principal Amount and Outstanding Principal Payment on Maturity

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Financial Management II

XLRI – PGDM 2015-18 Batch

Under this option the entire capital is to be financed through Debt with yearly interest payments and fixed principal payment of $6.5 million. The left over principal payment of $37.5 million is done on maturity. The yearly interest payment comes out to be $8.125 million for the first year and a decreasing interest payments every year with decreasing Principal with an interest rate of 6.5% every year. As tax benefit will be reaped by the firm on interest payment so Net Interest Payment comes out to be 5.28 (65% of 8.125) for the first year and similarly for other years. The Net present value comes out to be $106.07 million at a discounting rate of 6.5%.

C. Financing Entirely through Equity

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Financial Management II

XLRI – PGDM 2015-18 Batch

Earnings per Share - $1.91 Under this option the entire capital is to be financed through equity with yearly dividend payments of $7.5 million and maturity value will be given after 15 years. The dividend per share has been assumed to be $1 per share and with total 7.5 million shares; the dividend paid each year comes out to be $7.5 million. With price earnings ratio of other firms given and expected Earnings per share given for Winfield, the expected market price comes out to be 20.17. Calculating the terminal value gives a value of 151.25. Some assumptions have also been taken. Risk free rate assumed to be 4% (taken from US past year data). Stock price return also assumed to be 13.4% on the basis of actual data from various finance agencies. As the firm dependency on market performance is minimal so a low beta has been used for the calculation. On calculating Cost of Equity was foind out to be 6.82%. On discounting the payments for the 15 years at a discounting arte of 6.82%, NPV came out to be $125.31.

Return on Equity = Net Income/Average Stockholder’s Equity Net Income = 42,900 (Thousand of Dollars) Average Stockholder’s Equity = 685380+75000 = 760580 So ROE = 42900/760580 = 5.64% 5 | Page

Financial Management II

XLRI – PGDM 2015-18 Batch

D.Financing through Debt and Equity (Debt -75% and Equity – 25%)

Under this option the capital is to be financed through both equity and debt with 25:75 Ratio. The yearly dividend payments come out to be $1.88 million and maturity value will be given after 15 years. The dividend per share has been assumed to be $1 per share and with total 1.88 million shares; the dividend paid each year comes out to be $1.88 million. On discounting the payments made towards Equity at a Cost of Equity of 6.82% the NPV comes out to be $31.33 million 75% of the capital is to be financed through Debt with only interest payments every year and principal payment to be made after 15 years. The NPV for the Debt payments at a discounting rate of 6.5% comes out to be $73.70 million. Thus Net NPV for this option comes out to be $105.03 million.

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Financial Management II

XLRI – PGDM 2015-18 Batch

Conclusion Various Financing Options

Through Debt with Fixed Principal Payment

NPV

$98.26 million

EPS ROE

Through Debt with only Interest payment $106.07 million $2.51 5.48%

Through Equity

Through Debt – Equity ratio of 75:25

$125.31 million $1.91 5.64%

$105.03 million

Considering all the above calculations into account we find that NPV is least for the option Debt with interest payment and principal payment at end of maturity. Also the EPS (earnings per share) for this option is the highest with a value of $2.51. Even though return on Equity is not the highest in this case but overall this option looks better. Thus I would recommend going for the Debt option.

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