Case study 1 – Cost of capital

Arnold Athletic Supplies Case:

Arnold Athletic Supplies, INC. is a stall, publicly held company located between Dallas and Fort Worth. Arnold 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.

Arnold 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 return 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:

1. Swimming Supplies, 11% return, medium risk
2. Golf Equipment, 13% return, medium-high risk
3. Golf Supplies, 6% return, medium-low risk
4. Track Equipment, 8% return, low risk
5. Track Supplies, 10% 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 income statement. He reported that the stock was selling for $25 per share and that the firm’s sale and earnings were growing at a respectable 8.5% annually.

As the discussion shifted from the specific proposals to the need for