case study of Finance

For the case, students must summarize his/her individual analysis in a summary document/fact-sheet which is limited to 4-pages (not including attached spreadsheet)Understanding/Concise statement of Problem- 5 ptsRationale for each financing option considered including understanding of EBIT chart- 10 ptsAnnual cash outlays for each option – 10 ptsImpact of each decision – financial ratios, risk and return, corporate control and flexibility – 10 ptsSelling points (Pros and Cons) to each director; why financing option chosen – 10 ptsFormat and Layout of Information in supporting decision – 5 pts
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FIN 620 – Winfield Refuse Management, Inc. Case – Raising debt versus equity
In choosing the “best” financing option for Winfield Refuse Management, Inc.,
consider the following:
? Pros and cons of issuing debt versus equity – specific to Winfield Refuse
? Interpreting EBIT chart and how used in your decision making
? Annual cash outlays for each financing decision, especially annual cash
outlay in 2013 and 2030
? Risk and Return tradeoffs for bondholders versus stockholders – specific to
Winfield Refuse
? Impact of each financing decision on relevant financial ratios, impact to
control, corporate flexibility, increased risk
? Why your chosen financing option is the “best” for this company – how do
you address each director’s concerns
For exclusive use at Morgan State University, 2015
9-913-530
OCTOBER 22, 2012
W. CARL KESTER
SUNRU YONG
Winfield Refuse Management, Inc.:
Raising Debt vs. Equity
It was early June 2012, and Mamie Sheene was checking her team’s calculations yet again. The
next board of directors meeting was in just two days, and she needed to be sure her presentation was
perfect. As chief financial officer of Winfield Refuse Management, a vertically integrated,
nonhazardous waste management company, it was Sheene’s responsibility to lead the discussion on
how to finance a major acquisition. This question had led to contentious debate at the last board
meeting, and she needed to make sure that the board could reach a resolution this time.
Industry Background
In the United States, waste comprised two main categories: hazardous and nonhazardous. The
former was produced primarily by manufacturing, and its disposal was strictly regulated. Examples
of hazardous waste included infectious medical waste, asbestos, heavy metals, corrosive waste acid
or alkali liquid, and ignitable waste oil. The nonhazardous waste category included various types of
industrial waste, as well as municipal solid waste—what most people commonly referred to as trash
or garbage.
Private operators typically collected, processed, and disposed of nonhazardous commercial and
industrial waste. Municipal solid waste could be managed by the municipalities themselves, but
nearly 80% of this was also outsourced to the private sector. A waste management operator collected
the waste and then processed it for recovery (i.e., recycling), combustion for energy recovery, or
disposal. The typical operation was very asset-intensive and usually required local collection
vehicles, long-distance vehicles, transfer stations, material recovery facilities, disposal facilities, and
landfills.
The industry was highly fragmented, with a few national, publicly traded players such as Waste
Management Inc. and Republic Services competing with numerous regional operators. With a few
exceptions, most local and regional waste companies were privately held. Larger companies
benefited from economies of scale by controlling a larger inflow of waste, thereby increasing
throughput and using their processing facilities and landfills more efficiently. The waste
________________________________________________________________________________________________________________
HBS Professor W. Carl Kester and writer Sunru Yong prepared this case solely as a basis for class discussion and not as an endorsement, a source
of primary data, or an illustration of effective or ineffective management. Although based on real events and despite occasional references to
actual companies, this case is fictitious and any resemblance to actual persons or entities is coincidental.
Copyright © 2012 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
This document is authorized for use only in FIN 620 by Pamela Queen, Morgan State University from August 2015 to February 2016.
For exclusive use at Morgan State University, 2015
913-530 | Winfield Refuse Management, Inc.: Raising Debt vs. Equity
management market was growing slower than overall GDP, with the waste from an increasing
population offset by declining waste per-capita, thanks to increased recycling and composting.
However, the business usually generated very steady cash flows. Demand was predictable and
recession-proof, and most operators worked on multiyear contracts with their industrial and
residential customers (see Exhibit 1 for financial data of select publicly traded waste management
companies).
History of Winfield Refuse
In 1972, Thomas Winfield founded Winfield Refuse as a two-truck operation in Creve Coeur,
Missouri. In the four decades since, the company grew through a combination of organic growth and
strategic acquisitions. In 2012, it served nearly a half-million industrial, commercial, and residential
customers in nine states, primarily in the Midwest. Winfield’s assets included 22 landfills and 26
transfer stations and material recovery facilities, which served 33 collections operations. Although
the Winfield family kept several seats on the board, outside professional management had been
brought in during the 1980s. The current CEO, Leo Staumpe, had previously managed the Michigan
operation and served as COO before being promoted to CEO in 1997.
Since its founding, Winfield’s board had adhered to a consistent policy of avoiding long-term
debt. The steady cash flow generated by the business, short-term bank loans, and the proceeds of the
1991 public stock offering had been sufficient to meet its financing needs. As of 2012, the capital
structure consisted of common stock, with no interest-bearing debt. The Winfield family and senior
management held 79% of the common stock. The remaining shares were widely distributed and
traded infrequently in the over-the-counter market.
Expansion Opportunity
In its early years, Winfield relied primarily on organic growth to expand its operation. Starting in
the early 1990s, the company made a series of small, “tuck-in” acquisitions. It targeted companies
that would extend its geographic reach while creating economies of scale with its existing facilities.
The management team had proven successful in the post-acquisition phase, avoiding undue
disruption while efficiently integrating new companies into its operations. In 2010, Winfield began
actively seeking a larger acquisition target to solidify its competitive position in the Midwest. The
team had observed that major competitors, both publicly traded and private equity-backed, had
become more aggressive in executing a “roll-up,” or consolidation strategy, of smaller waste
management companies. Facing these larger, more efficient players, it was important for Winfield
Refuse to maintain a competitive cost position on a regional basis.
In mid-2011, after a study of several potential acquisition targets, Winfield began discussions with
Mott-Pliese Integrated Solutions (MPIS), a waste management company serving parts of Ohio,
Indiana, Tennessee, and Pennsylvania. The MPIS assets were not an obvious strategic fit with any
other likely acquirer, but its footprint would both improve Winfield’s cost position in the Midwest
and provide an initial entry into the mid-Atlantic region. Furthermore, the business was well-run,
with a strong management team that had consistently produced 12%–13% operating margins every
year for the past 10 years. The company was privately held, had virtually no long-term debt, and the
owners were looking for an exit. After some negotiations, Winfield and the MPIS management
reached an initial understanding, settling on an acquisition price of $125 million. The Winfield
management team believed this was a fair price. MPIS also indicated that it would accept up to 25%
of the purchase price in Winfield stock.
2
BRIEFCASES | HARVARD BUSINESS SCHOOL
This document is authorized for use only in FIN 620 by Pamela Queen, Morgan State University from August 2015 to February 2016.
For exclusive use at Morgan State University, 2015
Winfield Refuse Management, Inc.: Raising Debt vs. Equity | 913-530
Board Discussion
Leo Staumpe believed that MPIS was an excellent fit and offered tremendous revenue synergies
and cost reduction opportunities. The MPIS acquisition was large enough for Winfield that external
financing would be required. An investment bank had indicated that, barring a major market
decline, new common stock could be issued at $17.75 per share. Net of underwriting fees and
expenses, net proceeds to Winfield would be $16.67 per share. An issuance of 7.5 million shares
would be required for MPIS.
Winfield’s performance had been steady and the company reliably paid dividends. However, for
the past few years, the performance of Winfield stock had been disappointing (see Exhibit 2 for
profit, dividends, and stock price data). As a result, Staumpe and Sheene wanted to reconsider the
policy of avoiding long-term debt. They believed the anticipated stability of the combined WinfieldMPIS business would support such a decision. Sheene determined that the company could sell $125
million in bonds to a Massachusetts insurance company. The annual interest rate would be 6.5% and
they would mature in 15 years. Annual principal repayments of $6.25 million would be required,
leaving $37.5 million outstanding at maturity. Although the bonds’ repayment terms would create a
sizable on-going need for cash, Sheene believed that they were the best available to Winfield.
Because the interest payments on the bond would be tax deductible, Sheene felt that issuing debt
was the most economically attractive option. At Winfield’s current marginal tax rate of 35%, the 6.5%
rate would be the equivalent of 4.225% on an after-tax basis, due to the tax shield allowed on interest
payments. By comparison, Sheene calculated a 6% annual cash cost for a stock issuance netting
$16.67 per share if Winfield maintained a dividend payment of $1.00 per share.
At the board meeting in March 2012, the board agreed with Staumpe’s recommendation on MPIS
and unanimously approved the merger. However, there was decidedly less agreement on the matter
of financing. Sheene presented her cash cost calculations and her rationale for issuing a bond, and
she was taken aback as a contentious debate broke out among the board. Andrea Winfield
immediately challenged Sheene’s numbers, pointing out that annual principal repayments had been
excluded and that Winfield already had long-term liabilities (see Exhibit 3 for Winfield’s balance
sheet):
The stock issue clearly has a lower cost. The principal repayments on the bond mean we
have an additional $6.25 million cash outlay every year. That is over 9% of the bond issue.
With all our long-term leases, Winfield already has significant financial commitments.
Assuming this debt burden will increase risk and will lead to wild swings in the stock price.
Andrea’s uncle, Joseph Winfield, weighed in on the same side of the argument:
The math is very simple. With earnings before interest and taxes [EBIT] of $24 million,
MPIS will generate over $15 million each year after taxes. With an additional 7.5 million shares
sold to finance this and dividends remaining at $1.00 per share, that comes to just $7.5 million
annually. In terms of the new shares, MPIS clearly pays for itself—how can we say that we are
hurting existing shareholders? It’s obvious that the bond issue is a bad idea!
A third director, Ted Kale, took the opposite position and became rather agitated about what he
believed were Winfield’s grossly undervalued shares:
It would be a travesty for us to issue at a price of $17.75. Each of our major competitors has
a higher price-equity ratio than we do, and issuing new shares at this time would be a
disservice to shareholders. We also need to worry about diluting management’s control of
HARVARD BUSINESS SCHOOL | BRIEFCASES
This document is authorized for use only in FIN 620 by Pamela Queen, Morgan State University from August 2015 to February 2016.
3
For exclusive use at Morgan State University, 2015
913-530 | Winfield Refuse Management, Inc.: Raising Debt vs. Equity
Winfield by issuing equity. Taking this approach is a huge gift to new shareholders at the
expense of current ones!
Two other directors, Joseph Tendi and Naomi Ghonche, concurred with Kale about not issuing
new common stock, but argued that this needed to be measured in terms of earnings per share (EPS),
rather than book or replacement value. After making some quick calculations, Tendi explained:
We have to be careful not to dilute the stock’s value. The EBIT of the combined WinfieldMPIS entity would be $66 million. Issuing common stock would dilute EPS to $1.91. Using
debt, on the other hand, could bump the EPS up to $2.51. That makes this the right choice for
shareholders. The principal repayment obligation comes to $0.42 per share, but I think this is
irrelevant to the discussion.
Finally, James Gitanga, the newest addition to the board, weighed in with observations about
financing in the waste management industry:
All the other major players rely on long-term debt in their capital structures. Winfield’s
balance sheet is unusual in this industry, and I do not know if our policy against debt is
justified.
With no conclusion among the directors, Staumpe suggested finalizing the financing decision in
the June board meeting. This would allow Sheene and her team to prepare additional materials to
facilitate the discussion.
Now with the June meeting in just two days, Sheene once again thought through the many issues
and arguments raised in the prior meeting. She needed a way to focus the discussion. To help with
that, she designed a chart that compared the debt and equity alternatives (see Exhibit 4 for an
assessment of the financing alternatives).
4
BRIEFCASES | HARVARD BUSINESS SCHOOL
This document is authorized for use only in FIN 620 by Pamela Queen, Morgan State University from August 2015 to February 2016.
For exclusive use at Morgan State University, 2015
Winfield Refuse Management, Inc.: Raising Debt vs. Equity | 913-530
Financial data of select waste industry companies (Q2 2012 data, except where noted)
Exhibit 1
Market Cap.
($ billions)
Price-Earnings
Ratio
Return on
Avg Equity
Long-Term
Debt to Equity
$ 15.9
10.2
3.7
2.3
0.13
17.4
15.3
22.4
NA
NA
13.5%
7.8%
9.4%
9.0%
-139.5%
1.5
0.9
0.6
1.1
26.2
Waste Management
Republic Services
Waste Connections
Progressive Waste Solutions
Casella Waste Systems
Operating
Margin, 2011
13.5%
16.4%
21.1%
-4.8%
-4.7%
Winfield Inc, income, dividends, and stock price data (thousands of dollars except per-share
Exhibit 2
data)
Market Prices Per Share
Operating
Revenue
Income
Before Taxes
Income
After Taxes
Earnings
Per Share
Dividends
Per Share
325,088
349,556
371,868
379,457
383,223
395,440
410,223
32,509
35,655
33,097
35,290
38,002
40,539
42,121
21,456
23,889
21,546
22,903
24,853
26,350
27,379
1.43
1.59
1.44
1.53
1.66
1.76
1.83
0.85
0.90
0.90
1.00
1.00
1.00
1.00
2006
2007
2008
2009
2010
2011
2012E
Exhibit 3
High
Low
17.03
17.71
14.70
16.56
18.80
21.20
15.50
16.51
11.91
14.65
16.90
17.55
Winfield Inc., summary balance sheet (thousands of dollars)
2011
Cash
Accounts receivable
Prepaid expenses
Current assets
$
Net operating property
Goodwill
Other assets
Total assets
Accounts payable
Miscellaneous payables and accruals
Current portion, capital lease
Current liabilities
Capital leases
Common stock
Paid-in surplus
Retained earnings
Long-term liabilities and equity
Total liabilities and stockholders equity
27,330
48,741
7,488
83,559
522,043
101,423
42,656
$ 749,681
$
36,998
25,883
1,420
64,301
15,813
15
146,257
523,295
685,380
$ 749,681
HARVARD BUSINESS SCHOOL | BRIEFCASES
This document is authorized for use only in FIN 620 by Pamela Queen, Morgan State University from August 2015 to February 2016.
5
For exclusive use at Morgan State University, 2015
913-530 | Winfield Refuse Management, Inc.: Raising Debt vs. Equity
Exhibit 4
Post-acquisition EBIT chart
Possible recession
level of earnings
Expected postacquisition earnings
Bond with annual
principal repayments
EPS = $2.51
EPS = $1.91
EPS = $0.70
Calculation of points to determine lines (thousands of dollars except outstanding shares and
per-share data
EBIT = $66.0M
Bonds
Stock
EBIT = $24.35M
Bonds
Stock
EBIT
Interest, 1st year
Earnings before tax
Tax @ 35%
After-tax earnings
Shares outstanding (millions)
Earnings per share
Annual principal repayments
24,350
8,125
16,225
5,679
10,546
$
15.0
0.70
6,250
24,350
24,350
8,523
15,828
$
22.5
0.70
–
$
66,000
8,125
57,875
20,256
37,619
66,000
66,000
23,100
42,900
15.0
2.51
22.5
$ 1.91
6,250
–
Note: The effect of leverage and dilution are indicated by the differing slopes of the lines and can be expressed: “For each
million dollar change in EBIT, the bond plan brings a change in EPS that is $0.014 higher than the stock plan. Leverage is
favorable from EBIT of $24.35 million upward.”
6
BRIEFCASES | HARVARD BUSINESS SCHOOL
This document is authorized for use only in FIN 620 by Pamela Queen, Morgan State University from August 2015 to February 2016.

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