Executive Summary

Winfield Refuse Management Inc is a non-hazardous waste management company. As its chief
financial officer, Mamie Sheene is responsible for having a discussion and ensuring that the board
can finalize the financing of a major acquisition.

The waste management sector comprises a small number of publicly traded national companies
and many privately-held local and regional businesses. Due to a growing interest in recycling and
composting, the waste management market has been growing slower than the overall GDP.

Facing pressure from larger competitors and industry consolidation, Winfield sought to acquire
Mott-Pliese Integrated Solutions (MPIS) to maintain a competitive position. The management
team believed that the acquisition would improve the company's cost position through cost
reduction opportunities and provide an opportunity for expansion into the mid-Atlantic region.
Winfield and MPIS management have agreed on an acquisition price of $125 million. MPIS has
also agreed to accept up to 25% of the purchase price in Winfield stock.

The Winfield board has already approved the merger. Now the decision has to be made regarding
the financing of the merger. The various financing alternatives being considered by the board
member are as below,

● Winfield can finance the merger through common stock. An investment bank has
suggested that new common stock could be issued at $17.75 per share.

● The merger can be financed through debt. An annual principal repayment of 6.25 million
and the net tax over a period of 15 years.

The board is focused on finding a financing solution that will lower the overall cost of financing for
the company and increase its funds available for distribution to shareholders.

Company, Industry & Acquisition Analysis

About Company:

Thomas Winfield created Winfield Refuse in 1972. Throughout its existence, the firm expanded
through smart acquisitions and organic expansion. The firm serves over 500,000 clients in nine
states, including industrial, commercial, and residential users.

Since its inception, the firm has been a family business, with most of the board members being
family members having 79% of the Equity.

Being in the waste management industry, the company has 22 landfills, 26 transfer stations &
many recovery facilities. This has enabled Winfield to scale their operations and they had a steady
influx of waste for further processing.
Although contrary to the other major companies in the Waste Management industry, Winfield had
a policy of not taking any long term debts. The cash flows were majorly influenced by Sales
Revenue, Short Term Loans and Initial public offering (IPO).

The company started acquiring small companies as the Industry was going through a
consolidation phase as also discussed in the first session of FM2 (Industry goes through a
cycle of fragmentation and consolidation).

About Industry:
The waste management industry in the United States is in charge of the collection, transportation,
processing, and disposal of solid and hazardous waste.
Hazardous materials : corrosive fluids, industry waste, ignitable liquid
Non-Hazardous materials: domestic waste, street garbage

The Industry is also highly fragmented as mentioned in the case with the majority of the firms
being privately owned. The bigger firms enjoy more efficient operations in their processing
facilities since they are vertically integrated and have a steady inflow.The industry growth rate is
smaller than the GDP growth due to more people inclining towards recycling the waste. There are
no major fluctuations in the demand and firms enjoy a steady cash flow and multi year contracts.

About MPIS:
MPIS is a waste management company serving in Ohio, Indiana, Tennessee and Pennsylvania.
Although MPIS assets were not a good fit for Winfield, the board at Winfield believed it will provide
cost positioning and a chance to expand in mid-atlantic regions.Winfield and MPIS management
have agreed on an acquisition price of $125 million. MPIS has also agreed to accept up to 25%
of the purchase price in Winfield stock.

Issue -1: Financing Dilemma

Debt: There is an option to obtain debt from Massachusetts Insurance Company for $125
million.
Option 1: Fixed principal repayments

Annual Principal payment: $6.25 Million

Annual Interest Rates: 6.5%
Effective interest rate: 6.5% * (1-0.35) = 4.225%
Maturity period: 15 years
Principal outstanding at the maturity date: $37.5 Million
Option 2: Annual Interest Payments

Annual Interest payment (Pre-Tax): 6.5% of $125 Million = 8.125

Annual Effective Interest (Post Tax): 8.125 (1-0.35) = $5.28 Million
Maturity period: 15 years
Principal outstanding at the maturity date: $125 Million
Option 3: Equity
Shares to be issues: 7.5 Million
Price per share: $17.75 (effective price of $16.67/share)
Dividends: $1/share * 7.5 Million Shares = $7.5 Million every year
Cost of Equity: 6.74%
Dividend Growth Rate: 0.50% (Industry growth rate below the US GDP growth rate)
Terminal Value: $120.79 Million

Option 4: Equity (25%) + Debt (75%)

Debt Maturity: 15 years
Equity: 25% of $125Mn = $31.25Mn
Debt: $93.75Mn
Price Per Share: $16.67/share
No of Shares: 1.8746 Mn
NPV for Financing Options

Based on the calculations of all the available financing options, we find that the equity method of
raising funds will be very expensive when compared to financing through debt. The second most
preferred option can be “Debt with fixed repayments” or even “Equity + Debt” option. The most
preferred option is the “Debt with full principal paid at the last”.

Pros and Cons for selecting Debt Financing

Pros:
1. Tax Benefits (Tax Shield): Interest payments on Debt are Tax Deductible which helps in
reducing a firm’s overall tax liability and increases the profitability. This will reflect
positively on the share value generated for the shareholders.
 2. No Dilution of Ownership: Using Debt will make the owners retain their controlling stake
with 79% ownership. This was one of the main agenda for the owners while considering
options for financing.
3. Leverage: Debt financing will increase the Return on Investment of the firm and
considering the industry outlay, the firm should look forward towards consolidating by
raising capital using its strong brand value and company financials.
Cons:
1. Interest Payments: The firm will be liable to pay interest on the debt which can form a
significant part of the cash outflows. This can also affect the Net Operating Income of the
firm.
2. Restrictions: The financing entity may lay down terms and conditions for the operation of
the company including the use of funds.
Arguments against Issuing Equity
1. Costs: The company may fee for legal services and to the underwriter for issuing Equity
in the market
2. EPS: The current EPS may be diluted since the spread of the company’s profit will become
larger.
3. Loss of Control: The Owners would have to give up stake in the firm which is no go option
for them.
4. Stock Price Distraction: The Management can become more worried about the stock
market prices and may take steps to entice the market and shareholders which may be
not beneficial for the company.

Impact of Financing on the Shareholders

As we have established that financing the acquisition with bonds is the most optimal choice.
Furthermore, we will look at the impact of debt-financing on shareholders and the risk of the firm
post acquisition.

Impact on Shareholders:
The expected Earnings before Interest and Tax for Winfield (in 2012) is around $42M and that of
MPIS is $15M.
Using the exhibit 4, we have the below three possible scenarios:
● Scenario 1: EBIT- $24.35M which seems like the worst case possible and an unlikely
scenario as it is mentioned in the case that the industry experiences steady cash flow and
the demand is also predictable.
● Scenario 2: EBIT- $46M which is a possible recession scenario
● Scenario 3: EBIT- $66M, combined value (as mentioned above) and the most likely
scenario.

From the below EPS chart, it is clear that EPS is the highest for Scenario 2 and 3 with the financing
option as Debt as well as the Return on equity is highest for financing through bonds.
Issue-2: Should Winfield continue its policy of low long-term debt in an asset-intensive industry
where major firms rely on a long-term debt-heavy capital structure?

Analysis: With Winfield sitting on excess cash which isn’t useful in the firm’s activities, they are
not taking full advantage of available debt-based tax shields to generate value for the firm. This
is hindering the expansion opportunities that Winfield can explore by using the available debt
financing. To increase its size and competitiveness in the waste management industry, it would
be beneficial for Winfield to do away with this policy.

Recommendation and Conclusion

Based on our above NPA analysis, we recommend that Winfield Refuse Management Inc.
decides to fund the acquisition with debt alongside annual interest payments. Further, given the
fact that Winfield has low leverage in its current capital structure, Debt financing should be chosen
over equity financing.
Further, not retaining its low long-term debt policy would help Winfield take better financial
decisions and explore better expansion opportunities.

APPENDIX

Payment Schedule
WACC

NPV
Post Acquisition Scenarios