Fultex

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Fultex is a medium-sized producer of athletic uniforms, sportswear, sleepwear and a variety of fabrics. The company emphasizes the cost management therefore it can provide high quality products with low cost. Fultex's business expands from team uniform to retail business, and now Fultex is considering entering into department stores business and design additional clothing lines to enlarge its market.

The Board of directors has already voted to approve the acquisition of $81 million external funds and top management considers this project absolutely essential for Fultex to succeed in increasing the market share, though it is not expected to improve the firm's profitability in the near future.

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Cheap University Papers on Fultex

R.Craig Harrof, a board member, sent a memo to Elizabeth Bethea, the chief financial officer of Fultex, explained that Fultex is highly over leveraged based on the comparison of the firm's current, quick, debt, D/E, TIE, FCC ratios to the industry average. The company should not borrow to fund the $81 million expansion.

Elizabeth Bethea discussed the memo with William Gibbs, a vice president, that she is far from convinced the firm is over-leveraged and she believed that the firm has capacity to incur debt because of reasons.

1. We are more profitable than typical firm

. Our risk is low because we are well diversified

. We have customer loyalty

Anthony Barro, a major stockholder with 6% of the firm stock, prefers that Fultex issues debt to raise the fund needed because he feels that Fed will do everything to avoid recession and inflation will finally increase. On the other hand, most economists feel that Fed is very much concerned with containing inflation and economic downturn is quite likely. However, Bethea realizes that economic forecasting is an inexact science and majority opinions can easily be wrong.

The financial options

Stock Option. New common stock at $ per share included $ per share floatation cost.

Bond Option. 15-year debentures bearing 10% interest rate callable after eight years at a price of $1100. The indenture will not allow Fultex to issue any higher priority new debt, paying dividend in excess of 70% of income and it also carry a sinking fund provision.

Combination Option. The 50-50 mix of stock and bond option

Moreover, the firm might have to alter the method of production to stay alert for the possibilities of innovation and efficiency. The best guesstimate is that $10 to $0 million fund is needed and Fultex has roughly $5 million of liquidity at present.

Impact on Shareholder control

If the company raises ,700,000 common stock and formal shareholders do not buy more stock to maintain their position, the new stock option will definitely diminish shareholder's control.

If Fultex issues $81million bond, shareholders control will still be the same because there is no impact on number of equity.

Quantitative Analysis

Cost of financing

Issuing common stock. In order to finance $81 million additional fund needed, we need to issue ,700,000 shares at the price of $ per share, with $ per share being the flotation cost, which is the one time cost of financing and equals to 6.67% of the fund received.

Issuing 15-year debentures bearing an interest rate of 10%. This interest is higher than the cost from issuing common stock, we have to pay it on an annual basis and we have to start retiring the principal at the end of year 5.

Borrowing from the investment bank. In this case we don't know that rate of interest charged but normally it should be higher than the interest on bond and we have to repay it at the maturity date.

Ratio analysis

Fultex is a very healthy business. It has current ratio of .6 and quick ratio of 1.. Even though these numbers are less than industry average, it shows that the company's liquidity is good. Harrof also mentioned that Fultex is over leveraged when compared to the industry, but in fact its debt ratio of 50% is considered reasonable.

Impact on company leverage ratios in 16

For bond option, debt ratio will increase from50% to 56% and TIE will be reduced from 5. to .7. These ratios are above average yet acceptable. In stock option, debt ratio will fall to 6% and TIE will increase to 6.7. These are comparable to industry average. Combination option will reduce debt ratio to 46%, TIE of 4.76

Problem Statement

Fultex is in a very competitive industry. Its main strategy is the reputation in quality and styling. Since the company strategy is to expand into a wider range of the consumer market, Fultex needs to get an external fund of $81 million to develop a new R+D plant that will increase its market share. Fultex's board of directors has approved this additional fund needed already. However, there is a conflict between a board member, the CFO, and a major stockholder. The board member does not want Fultex to incur more debt, while the major shareholder does not want to lose his control, and the CFO believes that Fultex has capability to borrow.

The problem in this situation is 'How should Fultex finance its 81 million expansion and be in the best interest of all?'

Alternative

1. Issue ,700,000 common stock at $ per share.

. Issue $81 million 10% 15-year callable bond.

. Issue ,700,000 preferred stock at $ per share

4. Combination of a 50/50 mix of stock and bond.

5. Borrow $81 million from investment bank.

6. Ask Barro to commit $5 million and issue $56 million10% 15-year callable bond.

7. Borrow $15 million from investment bank to stay alert for possible innovation.

8. Educate Barro about the economic situation

. Educate Harrof about using the industry average.

10. Defer the expansion until we know the economic situation.

11. Lease the manufacturing facilities

1. Remain status quo

Recommendation

Fultex should issue ,700,000 common stocks at $ per share to finance $81 million expansion project because of the following reasons

1. This project is critical for Fultex success in increasing market share. Moreover, this project will support the strategy of providing good product quality and styles with relatively low cost.

. Cash outflow is the minimum.

. Due to economic forecast, recession is likely to occur and interest rate is expected to fall, therefore it is not good to borrow now.

4. Barro's interest of the firm will remain at 0% as he wishes. To maintain 0% control over the firm, he'll need to hold 4.14 million shares (additional 14,000 shares). Therefore, he only needs to put another $4.6million.

5. The company can access to equity market because it has been quite successful in its business area.

6. Current financial position is quite attractive to the investors

7. The debt ratio will reduce to 6% which is approximately the industry average and it will satisfy Harrof. Nevertheless, we must educate Harrof that we shouldn't rely on the industry average because every firm is unique.

8. Stock option incurs low risk.

. Stock option increases the financial flexibility of the firm, if they need more investment in the future.

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