raising debt vs. equity
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TRANSCRIPT
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
Winfield Refuse Management 3
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 Refuse Management 4
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
)
Winfield Refuse Management 5
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 (
$M
)
Winfield Refuse Management 6
Financing Alternatives Continued:
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
0
20
40
60
80
100
120
140
160
180
7.50
Dividend Payout ScheduleDividend
Year
Cash
Ou
tflo
ws
($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
Winfield Refuse Management 7
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
Winfield Refuse Management 8
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
Winfield Refuse Management 9
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.
Winfield Refuse Management 10
• 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
Expected EBIT of 66M
Even with Principal Repayments included on an Adjusted EPS basis, EPS with Debt Financing would be greater than EPS with Equity Financing
Winfield Refuse Management 11
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 (
%)
Expected EBIT of 66M
Debt financing options provide the highest expect ROE under likely EBIT scenarios.
Winfield Refuse Management 12
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.
Winfield Refuse Management 13
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
Winfield Refuse Management 14
• 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!
Winfield Refuse Management 16
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 $7.5M in dividends
Debt cash outflows with debt is for a finite period while stock dividend outflows are perpetual
Ted Kale Market price is too low (based on Price-to-book comparable). Issuing shares at low price and loss of management control is a disservice to current stockholders.
This is not the only criteria for financing. Price may be low due to a liquidity discount to trade OTC. P/B is not comparable when capital structure varies.
Joseph Tendi Principal repayment obligation is irrelevant to the financing decision
Principal repayment is relevant because it is a real cash outflow
James Gitanga Other major companies have long-term debt in capital structure while Winfield is unusual
Analysis shows Winfield has the capacity to take-on more debt in its capital structure.
Appendix
Winfield Refuse Management Inc.
Winfield Refuse Management 18
Summary of Financing Schedules
Winfield Refuse Management 19
Monte-Carlo Simulation: Estimated Combined EBIT
Note: Standard Deviation was calculated from last 5 year performance.
Std Dev AverageMIPS Before Tax 2,377 24,000 Winfield Before Tax 3,639 36,745
Winfield Refuse Management 20
Monte-Carlo Simulation: Estimated Retained Earnings in FY 2026
Note: Ending Retained Earnings= Beginning Retained Earnings + Net Income – DividendNet Income Standard Deviation=3.6
Winfield Refuse Management 21
Cash outflows for debt optionsDebt with fixed principal repayments: Financing Cash Flow ($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 ($M)2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Debt 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 Principal Repayments - - - - - - - - - - - - - - 125.0 Interest 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 Debt Outstanding 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 125.0 -
Tax shield 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 Interest Payment after tax 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 Principal Repayments - - - - - - - - - - - - - - 125 Net Cash Outflow 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 127.8 NPV 107
Winfield Refuse Management 22
Cash outflows for Equity optionsEquity: Financing Cash Flow ($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
Winfield Refuse Management 23
Cost of Financing (3.5% vs. 6.5%)
Debt with fixed
principal repay-ment
Debt Equity 75% Debt + 25% Equity
$0
$20
$40
$60
$80
$100
$120
$140
$160
$106$98
$145
$110
NPV of Financing Alternatives
NP
V o
f Fnanci
ng C
osts
($M
)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
)
NPV @ 3.5% NPV @ 6.5%
Change in Interest from 3.5% to 6.5% yields the same financing decision.
Winfield Refuse Management 24
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
$70
.00
-
0.50
1.00
1.50
2.00
2.50
3.00
3.50
Post-acquisition EPS
EPS (Debt)
EPS(Equity)
EPS (Debt+Equity)
Expected EBIT of 66M
EBIT ($M)
Winfield Refuse Management 25
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)
Expected EBIT of 66M
Winfield Refuse Management 26
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)
Expected EBIT of 66M