WABASH

COST OF CAPITAL EXERCISE

The Wabash Appliance Corporation is a medium-sized manufacturer of electrical household appliances headquartered in Lafayette, Indiana. Its primary products range from small electric toothbrushes and can openers up to window fans and vacuum cleaners. The firm's products are sold nationally under the Wabash label, a synonym for Hoosier quality and workmanship.

During the 1960s and the early 1970s sales and earnings had grown rapidly. Sales in 1962 were approximately $60 million, but had reached $180 million by 1972. Per share earnings and dividends more than kept pace. The relevant figures are contained in Exhibit 1.

In order to support the firm's expansion, substantial expenditures on plant and equipment were required during the period indicated. The majority of funds came from retained earnings and the private placement of debentures with insurance companies. In 1964, however, the company was forced to sell additional common stock because it felt that the debt level which would ensue from trying to borrow the money to keep up its expansion program would be excessive. In particular, possible adverse effects in its stock price were feared since, at the time, the firm's ratio of debt to total capitalization was already somewhat above the industry average of 30 percent. The firm's balance sheet as of December 31, 1972 is shown in Exhibit II.

Originally, the company's Board of Directors had established a policy of paying out half its annual earnings as dividends. The actual percentage varied from year to year because an attempt was made to stabilize the dividends despite fluctuating profit. By the late 1960s, this policy had been revised to set one-third of earnings as the target pay-out ratio due to the continuing need for capital. At their last annual meeting, the Directors announced that the 1973 dividend would