Winfield Refuse Management Inc.

Raising Debt vs. Equity

Iris Chen
Alex Ho
Brian Huang
Pramod Jindal
Michael Trecroce
Executive Summary
What is the best financing option for the $125M acquisition of Mott-Pliese
Objective
Integrated Solutions (MPIS)?

1. Debt with Fixed Principal Repayments

Alternatives 2. Debt
3. Equity
4. Debt & Equity

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

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

Recommendation
principal repayments

Winfield Refuse Management 2

Introduction

Winfield
Winfield MPIS
+ MPIS

Net Income Net Income Net Income

$27M + $15M = $42M

Region Region Region

Midwest Mid-Atlantic & Midwest & Mid-

Midwest Atlantic

Winfield Refuse Management 3

 Winfield’s Current Financial Position
Winfield’s Revenue and Net Income EPS and Dividends
Revenue Net Income DPS
$500 $50 $2.00

$400 $40

Net Income ($M)

$1.50
Revenue ($M)

$/Share
$300 $30
$1.00
$200 $20

$0.50
$100 $10

$0 $0 $0.00
2006 2007 2008 2009 2010 2011 2012E 2006 2007 2008 2009 2010 2011 2012E

Industry: Debt-to-Equity Winfield: 100% Equity Ownership

Equity Debt Winfield Family OTC

21%

50%
50%

79%

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 Financing Alternatives
Capital Needs: $125M
1. Debt with Fixed Principal 2. Debt
Repayments  15 years
 15 years  6.5% interest rate
 6.5% interest rate  Full principal paid at Year 15
 $6.25M annual principal payment
Debt with Fixed Principal Repayment Schedule Debt Schedule
45 Interest Principal 140 Interest Principal 125.00
40 37.50
120

Cash Outflows ($M)

35
Cash Outflows ($M)

100
30
25 80
20 60
15
40
10 6.25
6.25 20
5 8.13 8.13
0 2.44 0

Year Year

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 Financing Alternatives Continued:
Capital Needs: $125M
3. Equity 4. Debt & Equity
 7.5M new shares @ $17.75  25% equity, 75% debt
 Perpetual Dividend Payments  1.87M new shares @ $17.75
 Dividend Policy is $1.00/Share  Perpetual Dividend Payments
 Dividend Policy is $1.00/Share
Dividend Payout Schedule Debt (75%) and Equity (25%) Schedule
180 Dividend Dividend Terminal Value 160 Interest Principal Dividend Dividend Terminal Value

160 140
140
Cash Outflows ($M)

Cash Outflows ($M)

120
120
100
100
80
80
60 Principal:
60 93.75
40 40
Dividend:
20 20 1.87
Interest: 6.09
7.50
0 0

Year Year

Winfield Refuse Management 6

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

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Cost of Financing (NPV)1
NPV of Financing Alternatives
$160
Assumptions $145
$140

NPV of Fnancing Costs ($M)

Marginal Tax Rate 35% $120 $113 $117
$107
Beta 0.36
$100
Market Risk Premium 6%
Risk-free Rate (Rf) 3% $80
Cost of Equity2 (Ke) 5% $60
Cost of Debt3 (Kd) 3.5%
$40
Time horizon (Years) 15
Dividend per share $1 $20

$0
Debt with Debt Equity 75% Debt +
Fixed Principal 25% Equity
Repayments

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 financing
2Cost of Equity was calculated using CAPM formula
3Cost of Debt of 3.5% (Prime in 2012) was used rather than Initial Cost of Debt (i.e., 6.5% in 2012)

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 Earnings Per Share
Pre-acquisition EPS: $1.83
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
Post-acquisition Earnings Per Share
$3.50

$3.00
Earnings Per Share

$2.50
EPS (Debt)
$2.00

$1.50 EPS(Equity)

$1.00 Expected
EBIT of EPS (Debt+Equity)
$0.50
66M
$0.00
$46 $51 $56 $61 $66 $71 $76
EBIT ($M)

Debt financing options provide the highest expected EPS under likely EBIT
scenarios.
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Adjusted Earnings Per Share
• Adjusted EPS = (NI-principal repayment)/ number of shares

• Higher earnings per share with the bond option, even treating
principal repayments as “expenses”
Adjusted Post-acquisition EPS
$3.00
Adjusted Earnings Per Share

$2.50

$2.00

$1.50
EPS( Debt, including principal
repayment)
$1.00
EPS(Equity)
Expected
$0.50 EBIT of
$0.00
66M

EBIT ($M)

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 10
 Return of Equity
Pre-acquisition ROE: 4.01%
Debt Equity
Pros No impact on shares No impact on earnings
Cons Reduced earnings by interest Increased BV of equity
Expected 5.80% 5.25%
ROE Post-acquisition ROE
7.0%

6.5%
Return on Equity (%)

6.0%

5.5%

5.0% ROE (Debt+Equity)

ROE(Equity)
4.5%
Expected ROE (Debt)
4.0% EBIT of
66M
3.5%
$46 $51 $56 $61 $66 $71 $76
EBIT ($M)

Debt financing options provide the highest expect ROE under likely EBIT
scenarios.
Winfield Refuse Management 11
 Debt Service and Retirement Coverage
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
Debt Service Coverage Debt Retirement Coverage
21x 27x

16x 22x

17x
11x
12x
6x 7x

1x 2x
$46 $48 $50 $52 $54 $56 $58 $60 $693 $726 $759 $792 $825 $858
Combined Estimated EBIT (in $M) Estimated Retained Earnings by 2026 (in $M)

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

Winfield can safely meet debt obligations under all financing alternatives.
1Debt service includes interest and principal repayment except for the bullet year
2Debt retirement refers to ability to pay back the principal by end of the term
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 Dividend Payout Coverage
Assuming Winfield continues to pay $1 dividend per share to all of its
shareholders in each financing option:
Dividend Payout Coverage Ratio1
3x

2x

1x
46 48 50 52 54 56 58 60
Combined EBIT for any given year

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

Winfield can safely pay dividends to shareholders under all financing alternatives
1Dividend to 15M existing shareholders plus additional shareholders needed for the respective
option.
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Evaluation of Options & Summary
Debt with Debt (75%)
Decision Criteria Debt Principal Equity + Equity
Repayment (25%)
Cost of Financing
(NPV)
Expected EPS
Expected ROE
Risk Tolerance
represents the better alternative
(Coverage) represents the lesser alternative

• Other considerations
 By issuing debt, Winfield would avoid control dilution
 Flexibilities – sufficient cash flow to meet
commitments under all options
Winfield should finance the $125M through issue of bonds with no principal
repayments

Winfield Refuse Management 14

 Question & Answers

Thank you for listening to our presentation!

Concerns from Last Board Discussion
Concern
Andrea Winfield Stock issue is lower cost and
additional debt would increase
risk leading to swings in stock
price
Joseph Winfield By issuing 7.5M shares, Winfield
will only have to pay $7.5M in
dividends
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.
Joseph Tendi Principal repayment obligation is
irrelevant to the financing
decision
James Gitanga Other major companies have
Winfield Refuselong-term
Management
debt in capital structure capacity to take-on more debt in
Our View
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.
Debt cash outflows with debt is
for a finite period while stock
dividend outflows are perpetual
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.
Principal repayment is relevant
because it is a real cash outflow
Analysis shows Winfield has the
16
 Appendix

Winfield Refuse Management Inc.

Summary of Financing Schedules

Winfield Refuse Management 18

Monte-Carlo Simulation: Estimated
Combined EBIT

Std Dev Average

MIPS Before Tax 2,377 24,000
Winfield Before Tax 3,639 36,745
Note: Standard Deviation was calculated from last 5 year performance.
Winfield Refuse Management 19
Monte-Carlo Simulation: Estimated
Retained Earnings in FY 2026

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

Winfield Refuse Management 20

 Cash outflows for debt options
Debt with fixed principal repayments: Financing Cash Flow ($M)
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Debt 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

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 Cash outflows for Equity options
Equity: 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

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 Cost of Financing (3.5% vs. 6.5%)
NPV @ 3.5% NPV @ 6.5%
NPV of Financing Alternatives NPV of Financing Alternatives
$160 $160
$145 $145
NPV of Fnancing Costs ($M)

NPV of Fnancing Costs ($M)

$140 $140
$113 $117
$120 $107 $120 $110
$106
$98
$100 $100

$80 $80

$60 $60

$40 $40

$20 $20

$0 $0
Debt with Debt Equity 75% Debt + Debt with Debt Equity 75% Debt +
Fixed 25% Equity fixed 25% Equity
Principal principal
Repayments repayment

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

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EPS (with interest = 6.5%)

Post-acquisition EPS
3.50

3.00

2.50 EPS (Debt)

2.00
EPS(Equity)

1.50

EPS (Debt+Equity)
1.00
Expected
0.50 EBIT of 66M

-
EBIT ($M)
$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

Winfield Refuse Management 24

Adjusted EPS (with interest = 6.5%)
Adjusted Post-acquisition EPS
3.00

2.50

2.00

EPS( Debt, including

principal repayment)
1.50

1.00
EPS(Equity)

0.50 Expected
EBIT of
66M
-

Winfield Refuse Management 25

 4.0%
4.5%
5.0%
5.5%
6.0%
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

Winfield Refuse Management

$58.00
$59.00
$60.00
$61.00
$62.00
$63.00
$64.00
$65.00
$66.00
$67.00
Post-acquisition ROE

$68.00
ROE (with interest = 6.5%)

$69.00
$70.00
$71.00
66M
EBIT of
Expected
ROE

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

26