WMBA 6070 Week 6 Debt Versus Equity Financing Example

Take the Equity-Heavy Package to the Board: Financing a $9 Million Acquisition for a Crane Company, Where Debt Adds Eight Cents per Unit in a Normal Year and a Covenant Breach in a Bad One

Student Name

Walden University

WMBA 6070: Managerial Finance

Instructor Name

Month Day, Year

Take the Equity-Heavy Package to the Board: Financing a $9 Million Acquisition for a Crane Company, Where Debt Adds Eight Cents per Unit in a Normal Year and a Covenant Breach in a Bad One

The Expansion and the Two Packages

Brightwater, the made-up Fort Wayne crane company in this term's case, has agreed terms to buy a smaller crane and rigging company in Toledo for $9 million. In a normal year the Toledo business would lift operating income by roughly $1.3 million, to about $5.3 million. The board, made up of the two founding families and one outside director, must decide how to pay for it.

Two packages are on the table.

The debt-heavy package borrows the full $9 million as a term loan at 7.5 percent, adding $675,000 a year in interest. No new ownership units are issued.

The equity-heavy package sells 200,000 new ownership units for $6 million, at $30 a unit, to a regional private investment firm that would take a board seat, and borrows the remaining $3 million at 7.5 percent, adding $225,000 in interest. Brightwater now has 1,000,000 units outstanding, so the new investor would own about 16.7 percent.

Existing interest expense is about $1.76 million a year. The analysis applies a 21 percent tax rate to compare the packages on an after-tax basis.

Earnings per Unit and Coverage

Table 1

Earnings per Ownership Unit and Interest Coverage Under Three Operating Results

Earnings per unit = (operating income minus interest) x (1 minus 0.21) / units outstanding; coverage = operating income / interest. Composite figures.

In a normal year the debt-heavy package earns about $0.08 more per unit, a 3.7 percent advantage, because the owners keep all the acquisition's earnings without sharing them with a new investor. In a strong year the advantage widens to $0.18. In a weak year it reverses: the equity-heavy package earns more per unit, because the interest burden of the larger loan bites harder.

The two packages produce the same earnings per unit when operating income is about $4.69 million. Above that level, debt wins on earnings; below it, equity does.

The Coverage Problem

The more important figure is interest coverage. Brightwater's bank requires coverage of at least 2.0 times as a loan covenant. Under the debt-heavy package, coverage in a normal year would be about 2.18 times, a thin margin, and in a weak year it would fall to about 1.77 times, a breach. Breaking the covenant would hand the bank the right to call the loan or reprice it exactly when the firm could least afford either.

Coverage also drives the firm's borrowing cost. The January 2026 synthetic rating table for nonfinancial firms maps coverage between 2.0 and 2.25 to a Ba2/BB rating with a default spread of 1.84 percent, while coverage between 1.75 and 2.0 corresponds to B1/B+ with a spread of 2.75 percent (Damodaran, 2026). The debt-heavy package would leave Brightwater one weak year away from a lower rating and higher costs on future borrowing, including the private notes it plans to issue.

Weak years are not hypothetical. Crane rental depends on commercial construction, and Brightwater's operating income fell by about a fifth in its last downturn.

What Theory Says

Myers (1984) argued that firms reach first for retained earnings, next for borrowing and last for new outside owners, partly because issuing equity can signal that owners think their shares are overvalued and partly because outside equity brings outside scrutiny. That preference helps explain why the families lean toward debt. Yet the survey by Graham and Harvey (2001) placed financial flexibility and the credit rating near the top of what finance chiefs weigh when they borrow, and the coverage figures show the debt-heavy package would sacrifice both.

Recommendation to the Board

Take the equity-heavy package to the board. It gives up about eight cents per unit in a normal year, keeps coverage comfortably above the bank's covenant even in a weak year and preserves the firm's ability to borrow for the crane purchases planned in Weeks 1 and 5.

How the Bank Would Read Each Package

The bank that holds Brightwater's term loan and line of credit would read the two packages differently. Under the debt-heavy package, the firm's total debt would rise from about $24 million to $33 million against equity of about $30 million, and coverage in a normal year would sit only slightly above the covenant. The bank would likely ask for tighter covenants, a higher rate on any new borrowing or both. Under the equity-heavy package, debt rises only to about $27 million while equity rises to about $36 million, and coverage stays comfortably above the covenant even in a weak year. The bank's own view matters because Brightwater will need it again for the crane purchases planned this term.

A Middle Option Considered

A middle package, $4.5 million of new equity and $4.5 million of debt, was also examined. In a normal year it produces earnings per unit of about $2.20 and coverage of about 2.53 times; in a weak year, coverage falls to about 2.05 times, barely above the covenant. It splits the difference on earnings but leaves the firm exposed in exactly the scenario that matters most. The equity-heavy package is preferred because it is the only one with real room in a downturn.

Why the Board Would Accept It

The families' main concern will be control. The new investor would hold about 16.7 percent and one of four board seats, which leaves the families with a clear majority. The second concern will be price. At $30 a unit, the sale values the firm at the same multiple used in the Week 4 cost of capital memo, so the families are not selling cheaply. The third concern is that equity is expensive: the investor expects returns well above the cost of debt. That is true, but the cost of the debt-heavy package is not only its interest rate; it includes the risk of a covenant breach in the next downturn. Framed that way, the equity-heavy package is insurance the board can afford.

References

Damodaran, A. (2026). Ratings, interest coverage ratios and default spread [Data set]. NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ratings.html

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. The Journal of Finance, 39(3), 574-592. https://doi.org/10.1111/j.1540-6261.1984.tb03646.x