WINFIELD REFUSE WASTE

MANAGEMENT
Raising Debt vs Equity

Name Roll Number

Aakash Singh BJ22162
Dyuwan Shukla BJ22172
Ejya Singh Sharma BJ22173
Madhulika Singh Gour BJ22179
SUMMARY
The case is about Winfield Refuse Management Inc which is a privately owned non-
hazardous waste management company based out of US. It is amidst making a critical
decision on how to finance an acquisition of Mott-Pliese integrated Solutions (MPIS) and is
evaluating its options and choosing between debt, equity, or a combination of the two.

Market Landscape
Non-hazardous municipal solid waste is outsourced by municipalities to the private sector.
The operations although being very asset intensive is known for generating recession proof
very steady cash flows since the companies usually worked on multi-year contracts.
The Waste Management industry is a highly fragmented with few national and publicly
traded players and the management market is growing at a slower than overall GDP.

Company Background
Founded in 1972, Winfield Refuse management has grown from 2 truck operations based
out of Creve Coeur, Missouri to one of the largest privately owned waste management
company with 22 landfills and 26 transfer stations which served 33 collection operations.
The company’s current CeO, Leo Staumpe had been leading the company since 1997.
Winfield Refuse’ board of directors had kept a strict eye on the long-term debt exposure of
the company. The company had previously raised most of its capital using the equity with an
IPO in 1991. However, the Winfield family and the management still held on to 79% of the
shares.

MPIS Acquisition
Winfield refuse relied on a mixture of organic growth and small acquisitions to expand its
operational base. It had a good track record in avoiding undue disturbance post acquisition.
While trying to expand their presence in the Midwest, Winfield decided to acquire MPIS at a
cost of $125 Million, which was a significant player in Ohio, Tennessee and Pennsylvania but
didn’t have obvious synergies with Winfield. MPIS had no long-term debt of its own and
generated a steady operating margins of 12-13%.

LIST OF ISSUES IDENTIFIED

While evaluating the methods to raise $125 Mn in capital for the MPIS acquisition the board
members and Sheene are at odds to identify which of the following methods make the most
sense for the company:

1. Raising the $125 Mn through 100% debt at an interest rate of 6.5%. This would also
result in tax savings and the effective tax adjusted tax rate comes out to be 4.225%.
However, there would be a constant cash requirement to be furnished on an annual
basis for the firm to pay the interest and make the annual principal repayment of
$6.25 Mn.
2. Another alternative is to raise the money through equity by floating an additional 7.5
Mn shares at $16.67 per share (at $17.75 per share market value). A dividend of $1
per share would be given to the shareholders. There were 2 major viewpoints and
concerns on this:

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 a) Joseph Winfield says that since the MPIS generates $15 million in earnings after
tax the $7.5 Mn dividend burden can be met using this money.
b) Ted Kale was concerned about whether floating the shares at $17.75 would be
fair to the current shareholders as the company’s current P/E ratio is also lower
than its competitors.
c) Joseph Tendi and Naomi Ghonche brought forward an idea of using EPS as a
yardstick to determine our decision since raising through equity would decrease
the EPS as compared to choosing the 100% debt alternative even when we
account for the reduction in EPS due to principal repayment.
3. Finally, as MPIS had agreed to accept 25% of the acquisition amount in shares so this
opens us to an alternative where we can get a mixture of debt and equity to raise
the amount.

EVALUATING OUR OPTIONS

1) Present Value of future cash flows for 100% Debt
We have calculated the present value of the FCFs if the project is financed by 100%
debt

Debt Interest Rate Repayment Market Rate Rate of return

125 Mn 6.50% 6.25 Mn 4.225% 5.39%

Debt with Principal Repayment

Year Yearly Principal Principal Total Present
interest left Paid Payment value
2012 5.28125 125 6.25 11.53125 11.53125
2013 5.0171875 118.75 6.25 11.2671875 10.69094554
2014 4.753125 112.5 6.25 11.003125 9.906431428
2015 4.4890625 106.25 6.25 10.7390625 9.174199002
2016 4.225 100 6.25 10.475 8.490952544
2017 3.9609375 93.75 6.25 10.2109375 7.853596698
2018 3.696875 87.5 6.25 9.946875 7.259224593
2019 3.4328125 81.25 6.25 9.6828125 6.705106658
2020 3.16875 75 6.25 9.41875 6.188680093
2021 2.9046875 68.75 6.25 9.1546875 5.707538943
2022 2.640625 62.5 6.25 8.890625 5.259424769
2023 2.3765625 56.25 6.25 8.6265625 4.842217841
2024 2.1125 50 6.25 8.3625 4.453928866
2025 1.8484375 43.75 6.25 8.0984375 4.092691186
2026 1.584375 37.5 37.5 39.084375 18.74180903
Total Cost 51.4921875 - 125   120.8979972
NPV 120.8979972        

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 The Net present value of the payment through the 100% debt method is $120.8979
Mn.

2) Present Value of future cash flows for 100% Equity

Here we have assumed that the project is financed completely by equity and we
have attempted to calculate the present value of the future cash flows
Assumptions
 We have assumed the terminal value of dividend payments as the present
value
 We have taken beta as the unlevered beta (there has been some debt
component in the company’s portfolio)
 We have assumed the dividend growth rate as 0.5%

100% Equity Financing

Terminal Value Calculation
Growth rate 0.50%
Dividend Payout 7.5
Cost of levered equity 5.36%
Terminal Value 154.3209877

The present value of the dividend payout of the equity financing is 154.32 million USD.

3) Present Value of future cash flows for 75% Debt and 25% equity

The present value of the combined financing using debt and equity is 127.66 million USD.

Dividend Interest Principal Interest Cash Discounted

Paid Paymen Payment Post Tax Flow
t
2012 1.75 6.09375 6.25 3.960938 11.9609 11.96094
4
2013 1.75 6.09375 6.25 3.960938 11.9609 11.35225
4
2014 1.75 6.09375 6.25 3.960938 11.9609 10.77455
4
2015 1.75 6.09375 6.25 3.960938 11.9609 10.22624
4
2016 1.75 6.09375 6.25 3.960938 11.9609 9.70583
4
2017 1.75 6.09375 6.25 3.960938 11.9609 9.211906
4
2018 1.75 6.09375 6.25 3.960938 11.9609 8.743119
4
2019 1.75 6.09375 6.25 3.960938 11.9609 8.298187
4
2020 1.75 6.09375 6.25 3.960938 11.9609 7.875898

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 4
2021 1.75 6.09375 6.25 3.960938 11.9609 7.475099
4
2022 1.75 6.09375 6.25 3.960938 11.9609 7.094696
4
2023 1.75 6.09375 6.25 3.960938 11.9609 6.733652
4
2024 1.75 6.09375 6.25 3.960938 11.9609 6.390981
4
2025 1.75 6.09375 6.25 3.960938 11.9609 6.065748
4
2026 1.75 6.09375 6.25 3.960938 11.9609 5.757067
4
NPV 127.6662

Calculation of Cost of Capital

1) When raising 100% Equity funds -

New shares are issued at 17.75$ per share in price. After fees, the price per share comes to
$16.67, with an annual dividend payout of $1 per share, or an increase of $7.5 million of
cash outflow as dividend per year.
Online historical data allowed us to calculate the CAPM cost of equity, which came out to
5.1% unlevered.
(Assumption: Dividends will be paid out at a 0.5% annual growth rate because the waste
industry Is expected to trail US GDP. This is used to estimate the terminal value, used earlier
to calculate NPV from the Dividend Growth Model)

CAPM:
If all 125 million is raised through the issue of 7.5 million additional shares, at the net price
of USD $16.67, we would consider the Cost of Equity to be 5.1%.
This is calculated taking the following statistics from the web
 Market Risk Premium=5.5%
 Environmental Sector US Beta (Unlevered) =0.6
 Risk-Free Rate (10-year US treasury bond rate) = 1.8%
From CAPM, ke=1.8+0.6*(5.5) =5.1%

However, taking into account the current capital structure of Winfield, we find that it does
have some outstanding liabilities in 2012.
Hence, we calculate a levered Beta for the current Debt-Equity position, with a D/E ratio of
0.119650461 (Debt: 80114/ Equity:669567)
We hence obtain a levered beta at this position with 0.6*(1+(1-0.35) *0.119650461) =0.646
Hence, we find the levered Return on Equity as 5.3566, which is utilized in the calculations
above. However, this is only to allow us to make adequate comparisons between the 3
options and does not reflect the true cost of equity raised in the case.

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Assets Liabilities

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 Current Assets Short Term
Cash 27330 AP 36998
AR 48741 Misc payables 25883
Prepaid Expenses 7488 Current Portion, Capital lease 1420
83559 64301
Non-current assets Long Term
Net operating property 522043 Capital Lease 15813
Goodwill 101423
Other assets 42656 Owner's Equity
Sub-Total 666122 Common Stock 15
Paid-In surplus 146257
RE 523295
Sub-Total 669567
Total 749681 Total 749681
Dividend Capitalization Model:
For the equity raise, there are 3 major cost aspects
 Dividend Yield + Dividend Growth
 Underwriting Costs
 Underpriced Share issue

Taking the above into account and the case which states a 6% annual cash cost for stock
issuance at this price, we can state that the Cost of Equity raise is 6%+ v/s the effective cost
of debt which is 4.225%

1) 100% Capital from Debt

For the case of raising the entire 125 million as debt with interest rate at 6.5%, principal
repayments at 6.25 million for 15 years, we calculated the WACC, taking into account the
changes in the firm’s capital structure.
The calculations are performed below, in comparison with the 3rd case

1) 75% Capital from Debt and 25% from Equity for MPIS
This represents the case where 75% of 125 million= 93.75 million is raised in debt and the
rest as 25% of 7.5 million = 1.75 million shares of new stock, as indicated in the terms
acceptable to MPIS in the case.
It is also assumed in this case that the annual principal repayment remains the same for the
debt, with 6.25 million every year for 15 years, but no final 37.5 million additional principal
repayment.
The interest rate and tax shield applicable are considered to be the same.

Both the calculations for these cases are represented in the table below in a stepwise
manner.

(in 000’s) 100% Debt 75% Debt Raise

Debt Issued 125000 93750
Debt Standing Short term 64301 64301
Long term 15813 15813

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 Total 80114 80114
Total Debt 205114 173864
Equity 669567 669567
Total 874681 843431
D/E 0.306338275 0.259666322
D/V 0.234501493 0.206138973
E/V 0.765498507 0.793861027
Re(Unlevered) 5.1 5.1
Re(Levered) 5.757095601 5.65698426
Rd 6.5 6.5
Tax rate 0.35 0.35
Rd(Post-Tax) 4.225 4.225
WACC 5.397816896 5.361796496
B(levered) 0.719471927 0.701269865

Appendix
 Beta(Environmental Sector:2012)= 0.6
 Risk Free Rate: 1.8%
 Market Risk Premium: 5.5%

OPTIMUM ALTERNATIVES
 From the Cost of Capital calculated above, we see that the WACC for the 75% debt
and 25% equity alternative is slightly lower than that for pure debt at 5.361% against
5.397%, which are both better than the 6%+ cost of equity in a 100% equity raises.
This indicates a preference for taking on greater debt for Winfield, which is also
supported by the Net Present Values calculated for the three alternatives, where
pure debt presents the lowest capital outlay in terms of fund raise as compared to
the hybrid raise and even better against the pure equity capital raise. Hence, taking
into account the calculations raising the funds via debt financing appears to be
preferable.

 While calculating the present value of the future cash flows, in the three cases we
obtain the following results according to the above-mentioned calculations:
a) 100% debt financing: 120.89 million USD
b) 75% Debt and 25% Equity: 127.66 Million USD
c) 100% Equity Financing: 154.3 Million USD
As the present value of the cost Million incurred in these three cases is the least in
raising 100% debt, this should be our best possible recourse. Also, as similar
companies in the market have considerable debt in their portfolio, this shouldn’t be
a cause of worry for the board.
Sheene can counter the following arguments:
1) Andrea Winfield: As we have calculated the PV of debt repayments, considering
the annual principal repayments and the tax deductions based on the new
interest rates, we can comfortably show that debt financing is a better option.

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 Although we will be having 6.25 million USD more, but as the dividend payments
are being considered for perpetuity, the cost of equity financing incurred at the
present value is more.

2) Joseph Winfield: Although equity financing at the start does not seem like a
losing proposition, it should be noted that the earnings have been mentioned for
this particular year. It would be an overarching assumption that it would give
similar earnings till perpetuity. In the case of 100% debt financing, the repayment
obligations term state time period. Also, most importantly, debt financing has a
lower cost right now.
The company should go for debt financing.

References
https://www.statista.com/statistics/664840/average-market-risk-premium-usa/
#:~:text=The%20average%20market%20risk%20premium,and%205.7%20percent%20since
%202011.
https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart