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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?’
Point of view:
Areas of consideration:
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.