GB550 Unit 10 Financing Recommendation Example

Raising $93.5 Million Without a Share Issue: A Unit 10 Financing Recommendation for a Barge Fleet Program

[Student Name]

Purdue University Global

GB550: Financial Management

Unit 10 Financing Recommendation

[Instructor Name]

[Date]

The barge operator, its lenders and every figure are composite and illustrative; the standards and sources cited are real, and nothing here is investment advice.

Recommendation

The board should approve financing of $93.5 million from three sources: $42.0 million of twelve-year notes secured by the new tank barges at about 6.15 percent, $17.5 million from selling three towboats and chartering them back, and $34.0 million of operating cash retained over two years while the dividend holds at $0.96 a share. No new shares are issued. Debt reaches 2.77 times EBITDA in a normal year and about 3.6 times in a low-water year, under the 3.75 covenant, with interest covered 3.52 times. Three conditions must be met before any barge is ordered.

Sources and Uses

Uses. Replacement jumbo hoppers from Unit 7, $39.6 million; tank barges from Unit 8, $50.4 million; working capital for the tank barge contract, $2.2 million; financing and legal fees, $1.3 million. Total $93.5 million.

Sources. Secured equipment notes, $42.0 million; towboat sale-leaseback, $17.5 million; retained operating cash, $34.0 million. Total $93.5 million.

Why These Sources

Secured notes on the tank barges. Unit 3 showed that the company's barge-secured notes yield about 140 basis points less than its unsecured notes, because barges hold resale value. Pledging the new tank barges, which serve a contracted customer, lets the company borrow at about 6.15 percent for twelve years, longer than the eight-year contract but within the barges' working life.

Sale-leaseback of three towboats. The company sells three towboats for $17.5 million and charters them back for ten years. It keeps using the boats while turning their value into cash. The charter commits the company to fixed payments much like a loan, and current lease accounting puts the obligation on the balance sheet (Financial Accounting Standards Board, 2016), so the analysis counts its roughly $16.5 million liability as debt in every figure below.

Retained operating cash. After dividends and maintenance spending, the company generates about $17.0 million a year of cash it can retain. Over two years that funds $34.0 million, timed to the hopper deliveries, which arrive in two batches. Myers (1984) argues that firms prefer internal funds to outside financing because they carry no issue costs and send no signal to investors, and that preference fits here because the company can wait for part of the money.

Retained cash does the work of a share issue without its costs or its signal, as long as the company can wait two years for part of the money.

The Option Set Aside

A new share issue of about $35 million, the equity portion Unit 9 recommended, would cost about 5 percent in issue expenses, add about 1.6 million shares, diluting earnings per share by more than 5 percent, and, as Unit 4 showed, sell shares at a price that already reflects optimistic expectations. Because the hoppers are delivered over two years, retained cash can supply the same equity portion. The issue is set aside. A company with an urgent need and no cash to spare would weigh this differently.

Pro Forma Figures

Debt. Existing $420.0 million plus $42.0 million of new notes is $462.0 million; adding the $16.5 million lease liability gives $478.5 million.

EBITDA in a normal year. Current $156.5 million, plus $8.3 million from the tank barge contract and about $9.9 million from the jumbo hoppers' lower operating cost and added capacity, less about $2.0 million of new charter payments, gives about $172.7 million.

Debt to EBITDA, normal year. 478.5 / 172.7 = 2.77 times.

Debt to EBITDA, low-water year. In a year like the one replayed in Unit 9, with light loads on the hopper fleet and the charter payments still due, EBITDA would be about $133 million, putting debt at about 3.6 times, under the 3.75 covenant.

Interest coverage. Expected EBIT of $95.7 million against interest of $27.18 million, the current $24.6 million plus $2.58 million on the new notes: 3.52 times.

Market debt ratio. About 40 percent, the target set in Unit 9.

Graham and Harvey (2001) found that preserving a credit rating and financial flexibility rank among the strongest influences on corporate financing choices, and these pro forma figures keep the company inside both in a normal year and a plausible bad one.

Why the Mix Fits the Unit 9 Target

Unit 9 recommended raising about $55 million as debt and $35 million as equity to hold the debt ratio near 40 percent. This plan raises $42.0 million of notes and $16.5 million of lease liability, $58.5 million that behaves like debt, and $34.0 million of retained cash, which adds to equity just as a share issue would. The proportions are close to the Unit 9 split, with slightly more debt-like funding because the leaseback is counted in full. The difference from Unit 9 is the source of the equity, not its amount, and that difference saves the issue costs and the signal of a share sale.

Conditions Before Any Barge Order

A signed tank barge contract with a renewal option. Unit 8 showed the project's value depends on renewal and salvage; no tank barge should be ordered until the contract is signed, ideally with a renewal option or buy-back clause.

Committed lender terms. The secured note terms, including rate, term and covenants, must be committed in writing before the barge order, so the company is not exposed to a change in spreads after committing to the purchase.

A review after any second low-water year. If two low-water years occur before the retained cash is fully accumulated, the board reviews the hopper schedule before the second batch is ordered, since a second bad year could push debt toward the covenant.

Risks

Rates rise before the notes are priced. A one-point rise would add about $0.42 million a year of interest; coverage would remain above 3.4 times.

Operating cash falls short. If retained cash reaches only $25 million over two years, the second hopper batch is deferred rather than financed with more debt.

The leaseback buyer's terms change. The sale-leaseback is the least certain source; if it fails, the company could add about $17.5 million of secured notes on the towboats instead. Debt would then be about 2.74 times a normal year's EBITDA, since no charter payments would be due, but more of the fleet would be pledged and less would be left as collateral for future borrowing.

Conclusion

The program can be financed without new shares and without breaching the covenant in a bad year. Brealey et al. (2023) describe good financing as matching the source to the asset and the timing, and this plan does both: long secured debt for contracted barges, a leaseback for boats the company keeps using, and its own cash for hoppers it can buy over two years.

References

Brealey, R. A., Myers, S. C., & Allen, F. (2023). Principles of corporate finance (14th ed.). McGraw Hill.

Financial Accounting Standards Board. (2016). Leases (Topic 842) (Accounting Standards Update No. 2016-02).

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7

Myers, S. C. (1984). The capital structure puzzle. Journal of Finance, 39(3), 574-592. https://doi.org/10.1111/j.1540-6261.1984.tb03646.x