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lOMoAR
20893711
cPSD| 20893711

Winfield Refuse
Management, Inc.
David Vieira; Marc Brander; Maria Cunha;
Pedro Santos; Yuxuan Wang.

Applied Corporate Finance

April 3rd, 2018

[Type here]
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REPORT

Executive Summary

Company analysis

The acquisition

Recommendations

Appendix
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At a glance
• Winfield Refuse Management Inc. is a vertically integrated waste
management company, it operates on the non-hazardous waste sector in the
THE COMPANY Midwest region.
• Winfield Inc. has a rather unique capital structure in the industry as it kept
loyal to its policy of avoiding Long-term Debt.

• In order to keep up with the competitors consolidation strategy to benefit from

economies of scale and to augment revenues, Winfield is considering the
acquisition of Mott-Pliese Integrated Solutions (MPIS), for the amount of
THE TARGET $125M, a company that operates in the same sector and has virtually no LT
Debt.
• Such acquisition would allow Winfield to benefit from cost synergies in the
Midwest region, but also set foot in mid-Atlantic region.

• However, there is no consensus among the board of directors as to the way

of financing the acquisition. There are 4 forms available:
THE -Debt with fixed principal Repayments
FINANCING -Debt with only annual interest payments
DECISION -New stock issuance
-75% Debt + 25% Winfield’s stocks

WINFIELD SHOULD ACQUIRE MPIS WITH DEBT WITH ONLY ANNUAL INTEREST
PAYMENTS, AS THIS OPTION REQUIRES LESS $14M FINANCING COSTS THAN THE
2ND BEST OPTION
3
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REPORT

Executive Summary

Company analysis

The acquisition

Recommendations

Appendix
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Winfield Refuse Management

A small, publicly traded waste management company considers a major acquisition

The Profile of the Company Evolution of DPS and EPS

❑ Winfield Refuse Management Inc. is a vertically integrated waste 2.00
1.80
management company founded in 1972 by Thomas Winfield in 1.60
Creve Couer, Missouri. It dealt with non-hazardous waste. 1.40
1.20
❑ In 2012, served 500K clients in 9 different states in the USA. 1.00
❑ Like a company in the waste management industry, Winfield had a 0.80
0.60
large long-term-asset (LT) asset base: 22 landfills, 26 transfer
0.40
stations and recovery facilities. It allowed them to create economies 0.20
of scale as they had control over the inflow of waste. -
2006 2007 2008 2009 2010 2011 2012E
❑ Winfield had a policy of not using LT debt. Cash flow generated
Income Per Share Dividends Per Share
came from short-term (ST) loans, sales, and IPO (1991).
❑ Capital Structure: $80,114 in Debt + $669,567 in Equity. 79% of
equity was held by the Winfield family who were board members Capital Structure
and there was no interest bearing debt. 10.69%
❑ In its first years, Winfield relied on organic growth to expand their
business.
❑ In the early 90s started to acquire smaller companies (“tuck-in”
acquisitions). Targets were companies that helped create
89.31%
economies of scale with existing facilities and extend geographic
reach.
❑ Winfield’s performance and dividend payout have been stable.
Liabilities Equity

5
Source: Case data.
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Waste Management Industry

The industry where Winfield operates has some particuliarities

Industry Profile
❑ The waste management industry is divided in: hazardous (medical waste, asbestos,
heavy metals, ignitable oil, corrosive acids) and non-hazardous (municipal waste, street
garbage). Winfield dealt with non-hazardous garbage.
❑ Operations were very asset-intensive and required local collection vehicles, long-distance
vehicles, transfer stations, disposal facilities, and landfills.
❑ The industry is highly fragmented with several regional players that tend to be privately
held. Larger players benefit from economies of scale as they control the inflow of waste,
and thus, use their processing facilities and landfills more efficiently.
❑ Most operators work on multiyear contracts with industrial and residential customers.
❑ Waste management market grows slower than overall GDP, thanks to declining waste
per-capita (more people recycling). However, the business generates stable cash-flows,
demand is predictable and cycle-proof.

Points of Emphasis

High Capex Stable Cash-flows Low cyclicality

Source: Case data. 6

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Mott-Pliese Integrated Solutions (MPIS)

A potential $125M acquisition is on the table

The Profile of the Target

❑ In 2010, as means of solidifying competitive positioning in the Midwest, Winfield decided to acquire a
bigger player. Why? Competition was becoming more aggressive with their consolidation strategy of
smaller management firms who provided cost synergies.
❑ In 2011, Winfield decided to acquire MPIS, a waste management company that worked in 4 states.
❑ It wasn’t the best strategic fit in terms of assets.
❑ It allowed Winfield to improve their cost position in the Midwest, and to put a foot in the mid-Atlantic
region. The business was well-run, strong management, with operating margins of 12-13% in the last
10 years. Also, after being acquired it was projected to generate an EBIT of $24M per year.
❑ MPIS was privately owned, had no LT debt and owners wanted out to leave the business.
❑ After negotiations, the price of $125M was agreed. MPIS agreed that a maximum of 25% of the
purchase price was paid with Winfield shares.
❑ The board believed MPIS offered revenue synergies and opportunities to reduce costs.
❑ Winfield would need external financing to finance the deal. However, there was discord among board
members in relation to terms of the financing.

Points of Emphasis

Cost Synergies Market Expansion Financing

Source: Case data. 7
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Q1 - Winfield’s recent performance: Profitability

Winfield’s cash-inflows are cycle-proof but competitors are getting ahead

Growth and Profitability

❑ Margins and profits have been increasing, despite stagnation in levels of growth for both.
❑ Long-term liabilities over Equity was only at 2% when competitors had it in an almost 1-to-1 relation.
❑ Profitability ratios:
❑ Net Operating margin has been stable at around 6.5% since 2006. Although typical in this type of
business, some competitors achieve 13%.
❑ ROA and ROE of around 4%. Competitors had a median ROE of 9.9%.
❑ Winfield’s profits and margins were only slightly affected by the 2008 financial crisis.

Winfield’s Sales and Net Income Winfield vs Rivals

$420,000 $30,000
9.9%
$400,000 ROE
$25,000 3.9%
$380,000
$20,000
101.2%
$360,000 LT Liab./Equity
2.4%
$15,000
$340,000
$10,000 13.5%
$320,000 Net Profit Margin
6.7%
$300,000 $5,000
2006 2007 2008 2009 2010 2011 2012E -15.0% 5.0% 25.0% 45.0% 65.0% 85.0% 105.0%

Operating Revenue Income After Taxes Competitors Median Winfield

Source: Case data. 8

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Q1 - Winfield’s recent performance: Operations

Winfield’s operations have been stable

Liquidity and Operational Performance

❑ The firm seems to be able to pay debt that’s due in less than one year as the Current Ratio is 1.3.
However, when we look at the most liquid assets (cash and marketable securities) we see that they’re
less than half of current liabilities.
❑ Net Working Capital Requirements are negative as operating liabilities are higher than operating
assets. The firm holds no inventory and receivables are lower than payables, hence, the firm has a
negative cash conversion cycle. They don’t pay for their materials for until after they’ve sold the final
product associated with them.
❑ There’s a high fixed-rate turnover (75.75%), which is typical in this asset intensive turnover. Also,
Equity Turnover Ratio is 59% a lower value than most industries since we’re looking at very capital
intensive industry.

Winfield’s Operational Indicators NWC and Operating Cycle

$19,258
Equity Turnover 59.1%

FA Turnover 75.75%

Current Ratio 1.30 NWC NWCR

Cash/Current liab. 0.43

$(23,885)
0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40

Source: Case data. 9

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Q1 - Winfield’s recent performance: Financials

Winfield has too little debt and there’s a clear chance to create value through tax shields

Investing and Financing

❑ Winfields’ capital intensive business is heavily dependent on more
expensive funding as around 89.3% of the capital structure is
shareholders’ equity. Avg. Stock Price
❑ Winfield’s average stock price has been relatively stable across time. $20.00

❑ Net debt is negative at $27 million as financial assets are higher than $19.00
financial liabilities. The firm’s policy to avoid financial debt results makes $18.00
that they’re able to pay their financial debt obligations and capital leases
$17.00
and still have $10M in cash leftover.
$16.00
❑ This means that Winfield is sitting on cash and there are growth
opportunities not being taken. It’s an information asymmetry problem $15.00

due to the bad signaling that shareholder’s money isn’t being invested $14.00
and instead Winfield is using the cash as an insurance to weather the $13.00
storm in case distress situations occur in the future. 2006 2008 2010

❑ Winfield is resorting to more expensive financing and no present value of

future tax shields of debt.
❑ This strategy increases overall risk by destroying business value and
creates an overly confident management team. Managers are “better
protected” by lower levels of debt as there’s no disciplining factor of debt,
and thus, they have less control to pursue self-interest strategies like
empire building. The ones who benefit the most from this are the
Winfield family who own 79% of the company.

Source: Case data.

10
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REPORT

Executive Summary

Company analysis

The acquisition

Recommendations

Appendix
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Q2 - Financing alternatives: Debt

The Massachusetts insurance company may finance Winfield with $125M in debt via 2 options:

Payment Schedule with Fixed Principal The terms of both debt

Repayments options
40 37.5 Debt with fixed principal Repayments:
35
▪ Annual Payments divided in:
Cash-Outflow in M$

30
25
Principal payment (6.25M$)
20 +
15 Interest payment at a rate of 6.5%.
10 8.13 7.72 7.31
6.91 6.50 6.09 5.69 5.28 6.25 6.25
4.88 4.47 4.06 3.66 3.25
▪ Interest payments are tax deductible
5 2.84 2.44
0
▪ After tax cost of debt is 4.225% thanks to
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 interest tax shields.
Interest Principal Repayment ▪ Bonds have a maturity of 15 years, and on the
last year a principal of 37.5M$ has to be paid.

Payment Schedule With Plain Debt

140 125
Debt with only annual interest
payments
Cash-Outflow in M$

120
100 ▪ Annual Payments of:
80 ▪ Interest Payment at a rate of 6.5%
60 ($8.125M on a pre-tax basis)
40 ▪ Interest payments are tax deductible at a tax
20 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 rate of 35%. So, the after-tax cash-outflow of
0 the interests is $5.28M.
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
▪ Bonds have a 15-year maturity.
Interest Principal Repayment ▪ Full principal of $125M is paid in the last year.

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Q2 - Financing Alternatives: Equity

The acquisition could also go through via using the proceeds from a stock issuance or using a mix of Debt and Equity

Payment schedule and summary of the conditions of using Equity

180 ▪ 7.5M shares have to be issued.
160 154.19
▪ Price/share of 17.75$. After fees goes to $16.67/share
Cash Outflow in M$

140
120 ▪ Implies a total of $7.5M incremental dividend payout,
100 every year.
80 ▪ Dividend policy of $1/share.
60
40
▪ Using historical data provided by Aswath Damodaran we
20 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 obtained a cost of equity of 5.36%.*
0 ▪ Assumption: Payment of dividends a growth rate of 0.5%
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
as the Waste Industry is expected to grow below the US’
Dividend Payout Terminal Value GDP, and it’s a rather stagnant.

Payment schedule and summary of the conditions of using E+D

$300 ▪ MPIS indicated it would accept 25% in equity and 75% in
$250 debt. Debt maturing in 15 years and perpetual dividends.
$200 ▪ 1.875M (25%*7.5M) shares issued at a net price of
$150 16.67$/share. Dividend policy of $1/share, and
$100 assumption of g=0.5%.
$50 ▪ Dividend Payout/Year = $1.875M to MPIS.
$-
▪ Terminal Value (dividend) = $38.55M.
▪ Interest payment/year = $6.09M
Dividend Payout TV of Dividends Interest ▪ Last year’s principal repayment = $93.75M
Principal Repayment Total Cash-outflow

*Note: The unlevered cost of equity is explained in the next page 13

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Q2 - Net Present Value of Financing Options

From the two categories of financing alternatives, debt has the lowest cost

Inputs NPVs of the financing options

Data from January 2012 for the waste management industry $180
$154.23
and market information: $160
$147.32
❑ Beta = 0.48. Consistent with being a cycle proof industry $140
$120
❑ Risk-free rate = 1.76%. Used 15-year US T-bill. $99.71 $103.04
$101.31
$100 $85.89
❑ MRP = 7.5% $80
Discount rates: $60
❑ Cost of Equity (before debt issuance) = 5.36%. Used to $40
discount the equity financing option. $20

❑ Debt to Value (financing with debt) = 23.45% $-

1 - Debt with 2 - Debt with 3 - Equity 4 - 25% Equity +
❑ Debt to value (financing with 75% debt) = 10.70%. fixed principal annual interest 75% Debt
repayments payments
❑ WACC (debt financing) = 5.39%
NPV NPV with 0% growth rate in dividends
❑ WACC (debt and equity financing) = 5.38%

Points of Emphasis
▪ Issuing stock will have a higher cost when compared to financing the deal with debt. In fact, even with a mix of debt and
equity, the issuance of plain debt or debt with annual principal repayments are still preferred options.
▪ Debt cash-outflows have a finite period (15 years) whereas issuing debt implies paying perpetual dividends of $1 per
share issued. The firm relies on its reputation of reliably paying dividends and a deviation from this policy would have
negative consequences of Winfield’s reputation and firm value. Even if dividends stay at $1/share, the NPV of issuing
stocks is still lower than that of issuing debt.
▪ The acquisition of MPIS will have a lower cost if it’s financed with debt, ideally plain debt without fixed principal
repayments on an annual basis.

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Assessment of board members’ opinions

Most board members are keener on issuing shares to pay for MPIS.

Board Member Argument Assessment

1 Issuing debt is the most economically attractive
option, as the after-tax cost of debt (4,225%) is
Sheene lower than the cost of issuing equity netting $16,67
per share with a continued dividend of $1,00 per
share (a 6%).

2 The stock issuance has a lower cost, as with the

principal repayment the yearly outlay is an
Andrea additional $6.25 million per year (over 9% of the
bond issue). This debt will increase risk and lead to
wild swings in the stock price.

3 MPIS pays or itself: with an EBIT of $24 million

(over $15 million after taxes) and an additional 7.5
Joseph million shares issued to finance the operation, the
cost will amount to just $7.5 million per year,
considering a $1.00 dividend per share.

Erroneous Ambiguous True

Note: See next pages for substantiation of the arguments’ assessment. 15

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Q3 - Argument for Debt Financing

1 Issuing debt is the most economically attractive option, as the after-tax cost of debt (4,225%) is lower than the cost
of issuing equity netting $16,67 per share with a continued dividend of $1,00 per share (a 6% cost).

• Sheene argues, correctly, that the after tax cost of capital is lower than the current dividend yield. Considering the low
overall debt level, currently the benefits of debt seem to supersede its costs, making it an attractive financing option.
• Nevertheless, other considerations and criteria have to be analyzed in order to assess that debt is truly the best option,
i.e., we should look at the impact on firm’s shareholders (via return on equity), and at the firm’s ability to meet future
payment obligations (interest coverage ratio and dividend coverage). Only then can we conclude debt is the best option.

Pros of the Bond Issuance Cons of the Bond Issuance

❑ Increased management discipline: Managers are
subject to extra scrutiny by bondholders and have the
disciplining factor of having to meet periodic payments.
Thus, there’s a lower risk of agency problems like empire
building happening.
❑ Present value of future tax shields of debt: there’s
potential to generate value for the firm thanks to the
deducibility of interest payments which in turn reduce the
tax bill for Winfield.
❑ No Dilution: issuing debt will produce no changes in the
79% control of the business that the Winfields have. The
retention of control for the family may be a particularly
important factor when deciding the financing alternative,
as it’s of their interest to retain control.
❑ Management control is restricted (e.g. covenants). The
breach of a debt covenant will restrict managerial actions.
Existing managers, namely the Winfield family who owns
most of the business, may be reluctant to take on debt
because of this.
❑ Increased bankruptcy risk: makes both new debt and
current equity more expensive.
❑ Cash and collateral: Winfield plus MPIS will have to
produce enough cash-flows by the time of interest and
principal payments are due, otherwise covenants are
breached and credit ratings is downgraded, resulting in a
higher cost of capital. Also, collateral (most likely fixed
assets) will have to be posted to act as a guarantee.
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Q4 - The Cost of Equity Financing

The principal repayment should not be considered as cost of debt, but instead as a
change in the capital structure.
1 2 3

Total Cost of the equity issue:

If a company retains and invests earnings with
1. The cost of equity ROIC > WACC value is created, resulting in
higher share prices → return for shareholders
rE = dividend yield + capital gains
Dividends are one component of shareholder
remuneration; capital gains are the second
component. The cost of equity has to consider
both the dividend yield and the price
6% appreciation. The stock issue is diluting the
enterprise value among more shares
reducing the value of the stock
2. Spread/ underwriting discount comparatively to the bond option.

> 6% > 4.225% (after-tax cost of debt)

3. Underpricing

• Andrea ignores several cost elements associated with the stock issue, and considers the principal repayment as cost of
debt. Also, the NPV of both alternatives indicate stock is costlier, and additional debt will generate value for shareholders
due to tax shields.
• The optimal capital structure is one where the best combination of equity and debt maximize earnings and stock price. As
it is today, Winfield’s capital structure has too little debt, and inserting debt in it should be viewed favorably.
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Q4 - Maximizing Shareholder Value

Joseph is correct in stating that, even with equity financing, the acquisition adds value
to shareholders. However:
1 2 3

Do the arguments presented by the

Winfields matter?
❖ To Andrea: Stock issuance will likely have a higher cost in
financial terms but also result in a decline in stock price as a
consequence of bad signaling. Also, debt creates value.
❖ To Joseph: Joseph isn’t considering the time-frame
differences in cash-flows for both options, i.e., debt has a
15-year maturity while equity implies perpetual dividends.
The perpetuity of dividends has to be accounted, and the
payment of underwriting fees plus the underpricing of newly
stocks issued should be highlighted.
❖ The Winfields are pointing out arguments that seem to be
irrelevant from in the sense that they don’t matter for the
overall cost of the deal. Instead, they’re adopting a posture
consistent with their risk-aversion, in other words, refusing
long-term debt in their capital structure as they perceive it Higher EPS should
as riskier, and that could impose covenants on how the result in higher stock
family governs their company. They’re presenting
prices
arguments that matter for they way they want Winfield Inc.
to be managed.

A correct premise doesn’t ensure a correct conclusion. If the deal were to be

financed with an equity issue the company would forego a significant
amount of shareholder value.
18
Source: Case data.
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Q5 – Issuing Equity
Issuing equity would not only be costlier in dollar terms but also in other areas.
Downside of issuing new shares to
fund the acquisition of MPIS
❑ Transaction costs: fees have to paid to underwriters.
❑ Reputational costs associated with potential failure.
❑ Underpricing: shares of new stocks tend to be
underpriced. Why? Could be argued that the Winfield
family knows more about their business than outsiders,
and perhaps they’re selling new stock because they think
it’s overpriced. The fall of EPS may also be a reason
(despite being an accounting illusion).
❑ Management may be too distracted by the stock price.
Managerial actions may be distorted by focusing to much
on the stock price and trying to alter accounting numbers
just to meet investors’ expectations about the firm’s
quarterly results.
❑ Increased scrutiny from outside analysts and too much
focus on ST goals.
❑ The net present value of this financing alternative is
higher than that of debt.
❑ Ted Kale states that the company is undervalued, and
issuing shares at a lower price hurts shareholders.
Source: Case data.
Earings per share (EPS) and Price to
Earnings (PE ratio)
❑ If correctly priced the share price should not vary facing a
equity issue, as the value of current shares is not diluted.
❑ The board member, Ted Kale, brings out to the table that
the P/E ratio and EPS are powerful indicators for stock
under- or over-valuation, and also highly used by
analysts.
❑ Issuing at $17.75 would put Winfield’s P/E ratio
significantly bellow relevant competitors, pointing towards
an undervaluation of the stock at said price.
❑ He falls into a fallacy when presenting this argument:
o Price of Winfield may be too low as shares are only
traded in over-the-counter (OTC) markets.
o P/E ratios and EPS are only comprable when firm’s are
comparable, i.e., risk, growth, and cash-flow
characteristics. The universe of comprables presented in
the case have much more debt, and therefore, we cannot
use these metrics to compare firms that present
unidentical capital structures. A discussion around this
metric would be irrelevant.
o EPS and consequently can be accounting illusions.
Managers can play with their numbers to have higher
EPS, and transmit the idea that the firm is doing well.
19
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Q5 – Issuing Equity and adressing other board members

concerns
Debt increases EPS but this it doesn’t necessarily mean it’s a good thing.
Board Member Argument Assessment
4 It would be a travesty for us to issue at a price of
$17.75. Each of our competitors has a higher PE
Ted Kale ratio, and issuing new shares is a disservice to
shareholders.

❖ Debt can have the opposite impact of issuance of stock to finance a deal, as the
EPS increase.
❖ This is caused by the value/earnings creation of the present value of debt tax
shields and by pure financial leverage.
Answer to Mr. Kale ❖ There’s no clear sign that Winfield is undervalued. We cannot look at
comparable firms and derive Winfield is undervalued as they’ve got different
capital structures.
❖ If anything, according to the Efficient Market Hypothesis that “asset prices
fully reflect all information available”, Winfield’s stock price is fair.

5
Joseph Tendi Principal repayment obligation is irrelevant to the
financing decision.

Answer to Mr. Tendi ❖ Principal repayment is irrelevant as it’s a real cash-outflow.

Erroneous Ambiguous True

20
Source: Case data.
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Q6 - Management dilution
The financing of the deal presents a problem as it could potentially lead to managerial dillution which in the
case of this family owned business is exacerbated.

1. What is it? • An equity issue will dilute the stake of the Winfield family, that is, their 79% stake in Winfield will
decrease.
• This may raise management concerns as the powerbase in the company will shift. The current
owner may no longer meet voting majority thresholds.
• The board represents the interests of all shareholders, not specifically of the Winfield family. Thus,
this issue should not matter for the acquisition funding decision making process.
2. What’s its • In its essence it’s irrelevant for old shareholders’ wealth since the loss of control is offset by what
relevance? they gain from selling shares. However and in practical terms, dilution comes with underpricing
and issuing costs.
• The board cares as it’s mostly comprised be the Winfield family, and that’s why the issue of
dilution is being raised. The Winfields fear losing control over their company.
• As a family business the family will have a strong interest in remaining in control. Thus, they might
3. Is there a have an interest in debt financing even if it is more expensive than equity financing. This would
potential destroy value for the company, and hurt minority shareholders, who end up paying the price for
conflict of the family to remain in control.
interest? • Board members appointed by the Winfield family will have an incentive for them to retain power,
thus biasing their judgement. There’s a clear conflict of interests where the Winfields make the
decision of the company and hurt the other shareholders who own 21%.
• Separate control from ownership (e.g. issue shares without voting rights). The Winfield family gets
4. How can it those shares that have no voting rights, so that they don’t manage the firm they also own to the
be avoided? detriment of other shareholders.
• Have an independent corporate governance structure: A two-tier board with independent directors
and an independent committee.

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REPORT

Executive Summary

Company analysis

The acquisition

Recommendations

Appendix
 lOMoAR cPSD| 20893711

The optimal capital structure: a theoretical approach

Assuming the CAPM holds, shareholders demand a return based on company and
industry risk.

12.00%
Assumptions
10.00% • Risk free rate corresponds to the 10 year US
treasury bill yield
8.00%
• Market risk premium corresponds to the
excess return of the S&P 500
WACC

6.00%
• Unlevered beta from the US Environmental &
Waste Services industry, using Damodaran’s
4.00%
betas by industry analysis
2.00% • Beta was levered according to the following
formula, assuming a debt beta of 0:
0.00%
0% 20% 40% 60% 80% 100% 𝐷
Debt ratio 𝛽𝐿 = 𝛽𝑈 + 𝛽𝑈 − 𝛽𝐷 × 1 − 𝑡 ×
𝐸

There’s clearly space for more debt in Winfield’s capital

structure. A debt to value of around 40% corresponds to
the optimal capital structure whereby the WACC is
minimized (if the CAPM holds).
23
Note: Check appendix for table with calculations. Page 34 “Theoretical approach to WACC”
 lOMoAR cPSD| 20893711

Impact for shareholders and firm’s risk

Financing the deal with bonds is the most advantageous choice
Post-acquisition EPS chart Impact on Shareholders
$2.75 ❑ Winfield has an expected 2012 EBIT of $42M which is
paired with an EBIT of $15M for MPIS. The combined
Post-acquisition EPS

$2.25
value is around $66M (most-likely future scenario – 3),
and the recession scenario (2) suggests it’ll be $46M.
$1.75
Bond
The worst-case scenario (1) seems unlikely as in this
$1.25
Bond with principal repayments industry cash-flows tend to be stable, and demand cycle-
Stock proof.
25% stocks - 75% bonds
$0.75 ❑ EPS are higher with the debt options, for all likely
scenarios (2 and 3).
$0.25
$24,350 $46,000 $66,000 ❑ Under scenarios 2 and 3, the bond financing option
provides the highest Return on Equity (ROE)*. However,
Post-acquisition EBIT for Winfield + MPIS in M$ the bond with principal repayments gives the worst ROE.

Dividend coverage ratio Ability to meet obligations

3.0 ❑ Given the likely scenarios for future EBIT of the combined
Post-acquisition dividend

2.5 firm (EBITs of $44M and $66M), Winfield will be able to

safely meet their future interest payments*.
coverage ratio

2.0
❑ Winfield will be also able to pay the amount outstanding
Bond
1.5
Bond with principal repayments
for debt in the last year of the contract*.
1.0 Stock ❑ Winfield can safely pay future dividends to all
25% stocks - 75% bonds
shareholders (except in the catastrophic but unlikely
0.5
scenario of EBIT=$24M).
0.0
24,350 46,000 66,000
❑ Winfield should finance the $125M necessary through a
Post-acquisition EBIT bond issuance without annual principal payments (1st
choice) or with debt with annual principal repayments.
*Note: See pages 36 and 37 of the appendix for calculations on ROE, Dividend converage ration and principal coverage ratio. 24
 lOMoAR cPSD| 20893711

Q7 - Analysis and Recommendation Memo

The purpose of the following memo is to provide a detailed analysis and a subsequent recommendation on the proposed acquisition of Mott-Pliese
Integrated Solutions (MPIS) by Winfield Refuse Management Inc.. It’ll be divided in three sections: (1) Description of the problem; (2) Overview of the
provided solutions; (3) group’s advice on the best alternative.

1. Problem Statement
As a small, publicly traded company specializing in non-hazardous waste management, Winfield Refuse Management Inc. considers
a major acquisition of $125M in the Midwestern US. The acquisition can provide entry into the region, help the firm compete in a ferocious industry
with considerable amount of small local players, and improve its cost position. The acquisition will match Winfield competitors’ aggressive policy of
acquiring small companies, will produce synergies, and allow them to expand to 4 states of the mid-Atlantic region. The board saw the value of this
deal and approved the purchase of MPIS. Nonetheless, Winfield has a long-standing policy to avoid long term debt and until now has made a series
of small acquisitions using only equity and cash financing. The chief financial officer wants the board of directors to reconsider the policy and
suggests funding the acquisition through a bond issue. Several company directors disagree and prefer that the firm issue common stock. “What
would be the appropriate financing structure for the investment decision: Raising capital through Debt or Equity?”. In the next topic we try
to answer that question by addressing concerns raised during the board meeting and the financing conditions provided to Winfield.

2. Analysis of the financing alternatives

The analysis of Winfield’s profitability demonstrates a proven historical record of growth, with good strategic positioning in the
Midwest. However, direct competitors are getting ahead as they’re growing more organically (with higher growth rates in sales and fatter margins),
but also inorganically (with a large number of acquisitions of small local players to further extend their presence in the US). The waste management
business enjoys the perks of having low cyclicality, and very stable margins and profits, but at the expense of being stagnant and less innovative.
Thus, for Winfield the acquisition of a firm like MPIS that is present different geographical scope, has solidified operations, and shows good historical
growth, is a great chance to expand Winfield’s lines of business, and to increase their stable but rather constant profits.
The financial statements and operations of Winfield tell the other side of the story. The long-standing policy of not taking long-term
debt in its capital structure makes that currently only have around 11% of debt in its capital structure. The Winfield family has several members in the
board of directors, and from the remaining 89% of equity, they own 79%. Therefore, Winfield is resorting to more expensive financing and no present
value of future tax shields of debt is attained. With net financial assets $27 million, as financial assets are higher than financial liabilities, the firm’s
policy to avoid financial debt results makes that they’re able to pay their financial debt obligations and capital leases, and still have cash left of $10M.
Winfield is sitting on cash and there’s too little debt in its capital structure composition. Excess cash isn’t useful to run
operations, we’re not taking advantage of the present value of future tax shields to generate value for our firm. There’s also a bad signaling effect in
which shareholders interpret that the firm is sitting on the cash they’ve invested, rather than investing it into profitable investment opportunities, and a
second effect that issuing equity occurs where managers know more about their firm and issue equity as they think the company is overvalued.

25
 lOMoAR cPSD| 20893711

Q7 - Analysis and Recommendation Memo (cont.)

2. Analysis of the financing alternatives (continuation)
With the latter in mind we scrutinize the financing options brought to discussion by the board: (a) Debt with fixed annual principal
repayments; (b) Debt with only annual interest payments; (c) Equity; (d) 25% equity and 75% debt.
The conditions for (a) and (b) are set by the Massachusetts insurance company that’ll issue the bonds. The cost of debt for both will
be 6.5% and a maturity of 15 years. However, the first option will have an annual cost for the first 14 years of interest (6.5%*Debt outstanding) +
Principal Repayment ($6.25M). For the second option, the only cost is the interest of $8.125M ($125M*6.5%). They differ in the last payment as in the
first option the amount due is $37.5M, and in the second Winfield pays the full principal amount of $125M. Both options provide tax shield benefits.
For options (c) and (d), 7.5M and 1.875M shares would have to be issued, respectively. In the 100% financing with share issuance,
the net price will be $16.67/share, and the annual dividend payment (assumed to be perpetual) paid to new shareholders will be $7.5M. If the mixed
financing option (d) were to be chosen, 1.875M shares would be issued, the perpetual dividend payout would be $1.875M/year, there’d be an annual
interest payment of interest of $6.09M, and a last principal outflow of $93.75M.
After computing the appropriate discount rates, we arrive to the net present values of the costs of each financing choices (for further
details see pages 32, 33 and 34 of the appendix). It’s clear that the best alternative is debt (option b) costs $85.89M followed by option a) that costs
$99.71M), the mixture of debt and equity (d) comes second costing $103.04M, and equity (c) is costlier by far at $154M. So, the acquisition of MPIS
will have a lower cost if it’s financed with debt, ideally plain debt without fixed principal repayments on an annual basis.
It matters also to consider the impact on shareholders’ wealth and in the firm’s ability to meet future payment contractual obligations
(see pages 36 and 37 of the appendix). Our calculations indicate that, under the likely future scenarios for the combined firm, the bond financing
option provides the highest Return on Equity (ROE), and in all cases dividend payouts, interest and principal payments, they’re all going to be safely
paid by the firm.
Despite increased business risk that could result in a credit downgrade for Winfield, and despite cash and collateral considerations,
there are clear benefits of using leverage to finance the $125M purchase. (i) There’s a reduction on the tax bill thanks to the present value of future
tax shields, which in turn, creates value of the firm and its shareholders. (ii) There’s reduction of wasteful investment since too much financial slack
may encourage managers to take it easy, expand their perks, or empire-build (i.e. invest into ill-advised acquisitions) with cash that should be paid
back to shareholders. Debt can discipline managers because scheduled interest and principal payments force firms to pay out cash, leaving less free
cash flows to managers. (c) Managers facing higher leverage have lower degree of freedom to conduct self-interest strategies: the managers’ job
survival is at stake.
The Winfields are pointing out arguments that seem to be irrelevant in the sense that they don’t matter for the overall cost of the deal.
Instead, they’re adopting a posture consistent with their risk-aversion, in other words, refusing long-term debt in their capital structure as they
perceive it as riskier, and that could impose covenants on how the family governs their company. Some arguments didn’t consider the time-frames of
the financing options, others ignored other non-financial costs that come with issuing equity, and others looked at firms in the same industry but with
differing capital structures, to derive conclusions on how Winfield is undervalued given its PE ratio.
Another relevant issue is the management dilution. As a family business the family will have a strong interest in remaining in control,
and thus, they might prefer debt even if its more expensive or equity if its according to their risk-preferences – a clear conflict of interests. They call
the shots, to the detriment of other shareholders. This problem should be fought, via the creation of an independent committee without Winfields, or
the attribution of non-voting shares to the family.
3. Recommendation
Considering the calculated NPVs, the disciplining factor of debt, the little leverage capital structure of Winfield, and the bad signaling
indications of equity, debt is the recommendable financing option, preferably debt with interest payment and principal payment at end of maturity.
Notwithstanding, the interest rate on the bond seems high given the solid financial situation of Winfield, that is, Winfield should be able to find other
debt options with a lower cost of debt thanks to its good credit score.
26
 lOMoAR cPSD| 20893711

REPORT

Executive Summary

Company analysis

The acquisition

Recommendations

Appendix
 lOMoAR cPSD| 20893711

1A – Financial Statements
Price- Long-Term Exhibit 3 - Winfield, summary balance sheet
Market Cap. Return on Operating
Earnings Debt to
(billions) Avg Equity Margin, 2011 Thousands of dollars 2011
Ratio Equity
Waste Management 15.9 17.4 13.5% 1.5 13.5% Cash 27,330
Accounts receivable 48,741
Republic Services 10.2 15.3 7.8% 0.9 16.4% Prepaid expenses 7,488
Waste Connections 3.7 22.4 9.4% 0.6 21.1% Current assets 83,559
Progressive Waste Solutions 2.3 NA 9.0% 1.1 -4.8%
Casella Waste Systems 0.13 NA -139.5% 26.2 -4.7% Net operating property 522,043
Goodwill 101,423
Average 6.5 18.4 9.9% 6.1 16.97%
Other assets 42,656
Median 7.0 17.4 9.21% 1.0 13.47%

Total assets 749,681

Accounts payable 36,998

Exhibit 2 - Winfield Inc, income, dividend, and stock price data Miscellaneous payables and accruals 25,883
Current portion, capital lease 1,420
Thousands of dollars except per-share data Current liabilities 64,301
Operating Inco me Before Income After Income Per Dividends Market Price s Per Share
Revenue Ta xes (EBT)* Taxes Share Per Share High Low Capital leases 15,813
2006 $ 325,088 $ 32,509 $ 21,456 1.43 0.85 $ 17.03 $ 15.50 Common stock 15
2007 $ 349,556 $ 35,655 $ 23,889 1.59 0.90 $ 17.71 $ 16.51 Paid-in surplus 146,257
2008 $ 371,868 $ 33,097 $ 21,546 1.44 0.90 $ 14.70 $ 11.91 Retained earnings 523,295
2009 $ 379,457 $ 35,290 $ 22,903 1.53 1.00 $ 16.56 $ 14.65 Long-term liabilities and equity 685,380
2010 $ 383,223 $ 38,002 $ 24,853 1.66 1.00 $ 18.80 $ 16.90
2011 $ 395,440 $ 40,539 $ 26,350 1.76 1.00 $ 21.20 $ 17.55 Total liabilities and stockholders equity 749,681
2012E $ 410,223 $ 42,121 $ 27,379 1.83 1.00

28
Source: Case data.
 lOMoAR cPSD| 20893711

1B – Ratios and Relevant Metrics

1 - Redoing the Balance Sheet

1 - Profitability and Growth Assets Liabilities + Equity

1A- Growths 1B - Ratios Financial Assets 27,330 Operating Liabilities 80,114
Operating Assets 56,229 Financial Liabilities -
G(Op. Rev.) G(EBIT) G(NI) Net Profit LT Liab./Equity ROE ROA
Fixed Assets 666,122 Shareholder's equity 669,567
2006 6.60%
749,681 749,681
2007 7.53% 9.68% 11.34% 6.83%
2008 6.38% -7.17% -9.81% 5.79%
NWCR (23,885) Net Debt (27,330)
2009 2.04% 6.63% 6.30% 6.04%
Fixed Assets 666,122 Equity 669,567
2010 0.99% 7.68% 8.51% 6.49%
Capital Employed 642,237 642,237
2011 3.19% 6.68% 6.02% 6.66% 2.36% 3.94% 3.51%
2012E 3.74% 3.90% 3.90% 6.67%
Median of Competitors 13.47% 101.2% 9.93%
NWCR (23,885) Net Treasury Funding (27,330)
Fixed Assets 666,122 LT Debt -
Equity 669,567
642,237 642,237

LT Funding 669,567

Net Op. Profit 2011 26,350

ROCE 4.10%
Enterprise Value 642,237
Debt to Equity 11.97%
Liabilities 10.69%
Equity 89.31%
Net debt + Capital L (10,097)

Source: Case data. 29

 lOMoAR cPSD| 20893711

2 – Financing with Debt

1 - Debt Payment Schedule w/ fixed Principal Repayments
Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Debt 125 118.75 112.5 106.25 100 93.75 87.5 81.25 75 68.75 62.5 56.25 50 43.75 37.5
Interest 8.13 7.72 7.31 6.91 6.50 6.09 5.69 5.28 4.88 4.47 4.06 3.66 3.25 2.84 2.44
Principal Repayment 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 37.5
Debt Outstanding 118.75 112.5 106.25 100 93.75 87.5 81.25 75 68.75 62.5 56.25 50 43.75 37.5 0
Interest Rate 6.50%
Tax Rate 35%

Tax Shields 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
Interest Payment After Tax 5.28 5.02 4.75 4.49 4.23 3.96 3.70 3.43 3.17 2.90 2.64 2.38 2.11 1.85 1.58
Principal Repayment 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 37.5
Net CF 8.69 8.57 8.44 8.32 8.20 8.08 7.96 7.83 7.71 7.59 7.47 7.35 7.23 7.10 38.23

2 - Debt Payment Schedule with only interests paid annually

Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Debt 125 125 125 125 125 125 125 125 125 125 125 125 125 125 125
Interest 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125 8.125
Principal Repayment 0 0 0 0 0 0 0 0 0 0 0 0 0 0 125
Debt Outstanding 125 125 125 125 125 125 125 125 125 125 125 125 125 125 0
Interest Rate 6.50%
Tax Rate 35%

Tax Shields 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84
Interest Payment After Tax 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28 5.28
Principal Repayment 0 0 0 0 0 0 0 0 0 0 0 0 0 0 125
Net CF 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 127.44

Source: Case data. 30

 lOMoAR cPSD| 20893711

3 – Financing with Equity

1 - Dividend Payout Schedule

Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Additional Shares Outstanding 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
Dividend per Share 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
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
Terminal Value - - - - - - - - - - - - - - 154.19
g 0.5%
Re 5.36%

2 - 25% Equity + 75% Debt

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Dividend Payout 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88
TV of Dividends - - - - - - - - - - - - - - 38.55
Interest 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09
Principal Repayment 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 93.75
Total Cash-outflow 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 140.27

Source: Case data. 31

 lOMoAR cPSD| 20893711

4 - WACC
1 - Unlevered Re Industry Name Number of Firm s Average Bet a Market D/E Rati o Tax Ra te Unlevered Be ta Cash/Firm Valu e Unlevered Beta corrected for cas h
Beta Unlevered 0.48 Securities Brokerage 28 1.20 430.56% 26.22% 0.29 32.79% 0.43
D/E 0% Bank 426 0.77 156.11% 15.97% 0.33 11.41% 0.38
Rf 1.8% Financial Svcs. (Div.) 225 1.31 251.49% 19.18% 0.43 14.47% 0.50
Market Return 9.3%
Water Utility 11 0.66 81.42% 35.22% 0.43 0.38% 0.43
Re (unlevered) 5.36%
Natural Gas Utility 22 0.66 67.38% 30.16% 0.45 1.52% 0.46
2 - WACC 2B WACC of 25-75 option Utility (Foreign) 4 0.96 155.03% 26.07% 0.45 6.59% 0.48
New cap. Structure: New cap. Structure: Electric Util. (Central) 21 0.75 86.16% 31.82% 0.47 1.71% 0.48
Tax rate 35% Tax rate 0.35 Electric Utility (West) 14 0.75 84.54% 31.30% 0.47 2.57% 0.49
Debt Issued 125,000 Debt Issued 93.75 Environmental 82 0.81 43.70% 11.71% 0.48 2.88% 0.50
Debt after 205,114 Debt after 80,208
Equity 669,567 Equity 669,567
D/E 30.63% D/E 11.98%
Beta (levered) 0.53 Beta (levered) 0.50
WACC: WACC:
Re (levered) 5.75% Re (levered) 5.52%
Rd 6.50% Rd 6.50%
D/V 23.45% D/V 10.70%
E/V 76.55% E/V 89.30%
K 5.39% K 5.38%

32
Source: Case data.
 lOMoAR cPSD| 20893711

5 – NPVs Debt

1 - Debt Payment Schedule w/ fixed Principal Repayments

WACC 5.39%
Period 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
CF 8.69 8.57 8.44 8.32 8.20 8.08 7.96 7.83 7.71 7.59 7.47 7.35 7.23 7.10 38.23
Discounted CF 8.6875 8.127316 7.601714 7.108622 6.64609 6.21228 5.805464 5.424016 5.066405 4.731189 4.417014 4.122604 3.846758 3.588348 18.32533
NPV 99.71065

2 - Debt Payment Schedule with only interests paid annually

WACC 5.39%
Period 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
CF 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 2.44 127.44
Discounted CF 2.4375 2.312771 2.194425 2.082135 1.975591 1.874498 1.778579 1.687568 1.601214 1.519279 1.441536 1.367772 1.297782 1.231373 61.08442
NPV 85.88644

33
 lOMoAR cPSD| 20893711

5 – NPVs Equity
1 - Dividend Payout Schedule
Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Additional Shares Outstanding 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
Dividend per Share 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
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
Terminal Value - - - - - - - - - - - - - - 154.19
g 0.5%
Re 5.36%

Period 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
CF 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 7.5 161.6909
Discounted CF 7.5 7.118173913 6.755787 6.411849 6.08542 5.775611 5.481574 5.202506 4.937646 4.686269 4.447691 4.221258 4.006353 3.802389 77.80152
NPV 154.234

2 - 25% Equity + 75% Debt

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Dividend Payout 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88
TV of Dividends 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 38.55
Interest 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09 6.09
Principal Repayment 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 93.75
Total Cash-outflow 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 7.97 140.27

Computation of the NPV Re 5.38%

Net CF from debt 1.83 1.83 1.83 1.83 1.83 1.83 1.83 1.83 1.83 1.83 1.83 1.83 1.83 1.83 95.58
CF from equity 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 40.42271
DCF 3.703125 3.514158147 3.334834 3.164661 3.003171 2.849922 2.704494 2.566486 2.435521 2.311238 2.193298 2.081376 1.975166 1.874375 65.32548
NPV 103.0373

Source: Case data. 34

 lOMoAR cPSD| 20893711

6 - Theoretical Approach to WACC

2 - Theoretical Approach to WACC

D/(D+E) WACC ke kd of Debt βL D/E Rating Spread
0% 5.36% 5.36% 1.96% 1.27% 0.480947 0% AAA 0.20% Tax rate 35%
10% 5.19% 5.62% 1.96% 1.27% 0.515682 11% AAA 0.20% rf 1.8%
20% 5.01% 5.95% 1.96% 1.27% 0.559101 25% AAA 0.20% MRP 7.5%
30% 4.90% 6.37% 2.26% 1.47% 0.614925 43% AA 0.50% Bu 0.48
40% 4.87% 6.93% 2.76% 1.79% 0.689357 67% A 1.00% Bd 0
50% 4.91% 7.71% 3.26% 2.12% 0.793562 100% BBB 1.50% Rd 6.5%
60% 5.02% 8.88% 3.76% 2.44% 0.94987 150% BB 2.00% Ru 5.364%
70% 5.53% 10.83% 5.01% 3.25% 1.210383 233% B 3.25% EBIT (1-t) 66
80% 6.98% 14.74% 7.76% 5.04% 1.731409 400% CC 6.00% Vu 1,230.40
90% 9.52% 26.47% 11.76% 7.64% 3.294486 900% D 10.00%
40.17% 4.86% 6.93% 2.76% 1.79% 0.689357 Note: It's assumed that Winfield
will be able to finance themselves
at the risk-free rate plus a spread
calculated based on their credit
ranking, instead of the higher rate

Source: Case data. http://pages.stern.nyu.edu/~adamodar/ 35

 lOMoAR cPSD| 20893711

8 – Post-acquisition numbers
0. Post Acquistion data Catastrophic scenario Recession scenario Most likely scenario
EBIT = $24.35M EBIT = $46.00M EBIT = $66.0M
Bond w/
Principal
Bond w/ Principal 25% Stocks + Bond w/ Principal 25% Stocks + 25% Stocks +
Bond Stock Bond Stock Bond annual Stock
annual repayments 75% Bonds annual repayments 75% Bonds 75% Bonds
repayment
s
EBIT 24,350 24,350 24,350 24,350 46,000 46,000 46,000 46,000 66,000 66,000 66,000 66,000
Interest 8,125 14,375 6,094 8,125 14,375 - 6,094 8,125 14,375 6,094
Earnings before tax 16,225 9,975 24,350 18,256 37,875 31,625 46,000 39,906 57,875 51,625 66,000 59,906
Tax @ 35% 5,679 3,491 8,523 6,390 13,256 11,069 16,100 13,967 20,256 18,069 23,100 20,967
After-tax earnings 10,546 6,484 15,828 11,867 24,619 20,556 29,900 25,939 37,619 33,556 42,900 38,939

Shares outstanding (millions) 15.0 15.0 22.5 16.9 15.0 15.0 22.5 16.9 15.0 15.0 22.5 16.9
Earnings per share (EPS) $ 0.7031 $ 0.4323 $ 0.7034 $ 0.7032 $ 1.6413 $ 1.3704 $ 1.3289 $ 1.5371 $ 2.5079 $ 2.2371 $ 1.9067 $ 2.3075

1 - Impact for Shareholders - ROE and EPS

Price $ 16.67 # new share (M) 7500

Initial equity 669,567 # new shares of 25-75 option 1875

E after stock is $794,592

E' after stock i $700,823

EPS
EBIT Bond Bond with principal repayments Stock 25% stocks - 75% bonds
$ 24,350.00 $ 0.70 $ 0.43 $0.70 $ 0.70
$ 46,000.00 $ 1.64 $ 1.37 $1.33 $ 1.54
$ 66,000.00 $ 2.51 $ 2.24 $1.91 $ 2.31

ROE
EBIT Bond Bond with principal repayments Stock 25% stocks - 75% bonds
24,350 1.58% 0.97% 1.99% 1.69%
46,000 3.68% 3.07% 3.76% 3.70%
66,000 5.62% 5.01% 5.40% 5.56%

Source: Case data 36

 lOMoAR cPSD| 20893711

8 – Post-acquisition numbers

2 - Debt coverage: Interests and Principal

Catastrophic scenario (EBIT=24M) Recession scenario (EBIT=46M) Most likely scenario (EBIT=66M)
Bond 25% Stocks + 75% BoBond 25% Stocks + 75% BBond 25% Stocks + 75% Bonds
EBIT 24,350 24,350 46,000 46,000 66,000 66,000
Interest Expense 9,545 15,795 9,545 15,795 9,545 15,795
Interest Coverage Ratio 2.551 1.542 4.819 2.912 6.915 4.179

Catastrophic scenario (EBIT=24M) Recession scenario (EBIT=46M) Most likely scenario (EBIT=66M)
Bond Bond w/ Principal ann Stock 25% Stocks + 75% BBond Bond w/ Principal annuaStock 25% Stocks + 75 Bond Bond w/ Principal Stock 25% Stocks +
Yearly Dividend Payout 15,000.0 15,000.0 22,500.0 16,875.0 15,000.0 15,000.0 22,500.0 16,875.0 15,000.0 15,000.0 $ 22,500.00 $ 16,875.00
Retained Earnings (4,453.75) (8,516.25) (6,672.50) (5,008.44) 9,618.75 5,556.25 7,400.00 9,064.06 22,618.75 18,556.25 20,400.00 22,064.06
# Retained after 15 years (66,806.25) (127,743.75) (100,087.50) (75,126.56) 144,281.25 83,343.75 111,000.00 135,960.94 339,281.25 278,343.75 306,000.00 330,960.94
Principal due 125000 37500 125000 125000 37500 125000 125000 37500 125000
# remaining after principal is paid (191,806.25) (165,243.75) (200,126.56) 19,281.25 45,843.75 10,960.94 214,281.25 240,843.75 205,960.94
Debt retirement coverage (0.53) (3.41) NA (0.60) 1.15 2.22 NA 1.09 2.71 7.42 NA 2.65
Dividend coverage ratio 0.703 0.432 0.703 0.703 1.641 1.370 1.329 1.537 2.508 2.237 1.907 2.308

Interest Coverage Ratio

EBIT Bond 25% stocks - 75% bonds
24,350 2.55 1.54
46,000 4.82 2.91
66,000 6.91 4.18

Principal Coverage ratio

EBIT Bond Bond with principal repayments Stock 25% stocks - 75% bonds
24,350 (0.53) (3.41) NA (0.60)
46,000 1.15 2.22 NA 1.09
66,000 2.71 7.42 NA 2.65

Dividend coverage ratio

EBIT Bond Bond with principal repayments Stock 25% stocks - 75% bonds
24,350 0.703 0.432 0.703 0.703
46,000 1.641 1.370 1.329 1.537
66,000 2.508 2.237 1.907 2.308

Source: Case data 37