Question

Case study 1- Cost of capital Arnold Athletic Supplies Case: Amold Athletic Supplies, INC. is a stall, publicly held company located between Dallats and Fort Worth. Amold manufactures a variety of supplies and small equipment used by players and coaches around the country. Over the past 15 years, Arnold has had particular success in the high school and junior college markets; its products can be found in most dressing rooms of football, and basketball teams throughout the Southwest and Midwest Amold is considering expanding into product lines. Its well established sales force will be able to handle supplies and equipment for sports such as swimming. golf and track through it's a current activities in high school and junior colleges. The marketing manager and the director of finance have begun working on figures, related to the profitability of different athletic supplies and equipment. At this time, five possible markets have been identified and the likely retun on a cash flow basis has been determined for each. Specific proposals have been drafted and will soon be available for internal distribution in the company. In the meantime, the president has been given the after tax internal rates of return for each proposal as follows Swimming Supplies, 10% return, medium nsk . 2, 3, 4, 5, Golf Equipment, 14% return, medium-high risk Golf Supplies, 7% return, medium-low risk Track Equipment, 8% return, low risk Track Supplies, 1 1 % return, medium risk At a meeting of the board of directors called to discuss the proposal, the director of finance presented financial data, including the current year's balance sheet and statement. He reported that the stock was selling for S30 per share and that the firm's sale and earnings were growing at a respectable 9% annually. As the discussion shifted from the specific proposals to the need for financing, the director of finance was asked to make a recommendation. He had been studying different possibilities and was prepared to discuss specifics. "1 recommend." he began, "that we do not attempt to raise separate funds for a series of small projects. Rather, I suggest that we to raise $5 million to cover whatever proposals are finally accepted by this board. If this seems logical, I have investigated three altenatives that currently seem to be possible. 1. We can issue $4 million in bonds. Our investment banker believes that we would be able to float a $5,400,000 offering with a 100% coupon to net us the $5 million. If this is done we will have a debt equity ratio near P1, an acceptable ratio for our firm. We can sell 51,177 shares of preferred stock. Our banker feels that a 6% offering would be successful and would net us $5 million as $ 100 par. Most of the shares would probably be purchased by our existing common sharcholders, but a strong 2.