John Axelrod, treasurer of the American Forge Corporation is currently reviewing a series of financing options. The options include a five-year private placement of debt, a ten-year public debt issue, a ten-year public issue of convertible debt and a common stock issue. The proceeds will be used for a $10 million production facility expansion which will allow AFC to develop an aluminum engine for small aircraft.
The proposed engine investment is expected to yield an internal rate of return of almost 20 percent after taxes for at least ten years. This comes at a time when the company has greatly improved their profitability. Earnings doubled in 1982 as a result of improvements in the gross margin. The company's gross margin improved to more than 16% of total sales. This can be attributed to AFC's continued efforts of weeding out unprofitable and marginal products. Although the company's recent performance is promising, the only foreseeable source for an increase in earnings is the aluminum engine project.
Although the company is very excited about the aluminum engine project, there are some concerns and risks. For instance, market acceptance, even for a superior machine, might be more difficult to achieve than anticipated. Production costs might vary significantly from engineered levels. New alloys could make the engine obsolete. In summary, given the risks associated with the competitive and technological uncertainties of the aluminum project and the company's current earnings outlook, AFC could be severely set back if the project fails.
In his meeting with the investment bankers, John Axelrod has expressed several objectives which AFC is seeking to meet with the chosen financing alternative. AFC would like to keep their debt service coverage as low as possible. This is considered important because of the inherent risk involved with the fairly volatile machine tool industry. The company would like to keep the...