Case 5: Financing PPL Corp.’s Growth Strategy
1. Evaluate PPL’s growth strategy and financing policies. Why is it important for PPL to seek out alternative financing strategies instead of using its own corporate balance sheet?
In the early 1990’s, the anticipation of deregulation in the electricity marketplace led PPL to change its business strategy. It was essential for them to enter the market as soon as possible or they may have faced barriers to entry. In 1994, PPL established a new subsidiary now known as PPL Global. PPL Global pursued opportunities in the deregulated electricity market and was employed its growth strategy for the future. They specifically ...view middle of the document...
These instances would hinder the use of its corporate balance sheet and led to PPL seeking new strategies.
2. What are the advantages of using leases over corporate debt? Do they apply to PPL and the financing of its peaking power plans?
Leases were relatively more valuable to PPL than corporate debt due to the following reasons:
1. The risk of the salvage value is transferred from the lessee to the lessor.
2. Lessees can finance the capital cheaply using leases as they can pass on their tax benefits to the lessor for a lower interest rate. (However, this gain would result only when lessees having lower marginal tax rates than the lessors).
3. Leases can also help by making the balance sheet more beneficial to lessees as now the depreciation costs can be completely eliminated.
PPL being an Energy company was a part of a highly capital intensive industry. The large number of assets on its books on purchasing would lead to very high depreciation costs for the company. This problem could be prevented by leasing their assets. Entering into leasing contracts had other benefits for PPL as it would lead to higher earnings which would in turn lead to an increase in value for shareholders. The company would be able to fulfil its mandate of acquiring financing cheaply as well as, enter into further arrangements to keep the debt off its Balance Sheet. Even though PPL was looking to enter into leasing contracts, the management of PPL also planned to be an “asset backed” organization which means they would own the assets that they were using to produce energy
3. Among the various leasing options available to PPL (e.g., capital lease, leveraged lease, traditional synthetic lease, limited recourse synthetic lease, etc.) which do you think is most appropriate?
PPL had been facing problems when analyzing the standard methods of financing involving their balance sheet. The management felt that their stock was undervalued and issuing equity would not be the best of situations for PPL. They were not interested in debt financing either as they felt adding debt to the balance sheet would not be a good idea in a capital intensive industry where the returns take time to materialize.
We think the most appropriate option for PPL would be the traditional synthetic...