Today, O’ Grady Apparel Company is a small manufacturer of fabrics and clothing whose stock is traded in the OTC market. In 2015, the Los Angeles – based company experienced sharp increases in both domestic and European markets resulting in record earnings. Sales rose from $ 15.9 million in 2014 to $ 18.3 million in 2015 with earnings per share of $ 3.28 and $ 3.84, respectively.
European sales represented 29 % of total sales in 2015, up from 24 % the year before and only 3 % in 2010, 1 year after foreign operations were launched. Although foreign sales represent nearly one-third of total sales, the growth in the domestic market is expected to affect the company most markedly. Management expects sales to surpass $ 21 million in 2016, and earnings per share are expected to rise to $ 4.40.( Selected income statement items are presented in Table 1.)
Because of the recent growth, Margaret Jennings, the corporate treasurer, is concerned that available funds are not being used to their fullest potential. The projected $ 1,300,000 of internally generated 2016 funds is expected to be insufficient to meet the company’ s expansion needs. Management has set a policy of maintaining the current capital structure proportions of 25 % long-term debt, 10 % preferred stock, and 65 % common stock equity for at least the next 3 years. In addition, it plans to continue paying out 40 % of its earnings as dividends. Total capital expenditures are yet to be determined.
Jennings has been presented with several competing investment opportunities by division and product managers. However, because funds are limited, choices of which projects to accept must be made. A list of investment opportunities is shown in Table 2. To analyze the effect of the increased financing requirements on the weighted average cost of capital( WACC), Jennings contacted a leading investment banking firm that provided the financing cost data given in Table 3. O’ Grady is in the 40 % tax bracket.
TABLE 1 Selected Income Statement Items