Roxanna Garner The Small Regional Equestrian Leather Goods Company - Finance Assignment Help

Assignment Task

Roxanna Garner had spent a decade transforming Langtry Falls (Langtry) from the small regional equestrian-leather-goods company her grandmother had founded to a fast-growing, high-end leather-fashions business. The shift in focus from chaps and bridles to handbags and device cases had not been difficult. Many of Langtry’s suppliers spanned both worlds, and the workers who manufactured Langtry branded goods in its Texas studio embraced the shift in output. Furthermore, the focus on quality and artisanship that had established Langtry’s original reputation was a great selling point and differentiator in the fashion business. The real struggle was the shift in competition—the equestrian-goods market was fragmented, and reputation was built regionally by word of mouth, whereas Langtry now competed in a space dominated by large global brands that spent heavily on production efficiencies and advertising.

Langtry’s history and future were very much on Garner’s mind when she sat down in summer 2017 to consider a major expansion in its production facilities. Over the last six years, the company had been growing steadily, at times even briskly, despite a weak economy both locally and globally. The planned expansion was intended to position the company to handle anticipated growth in its most successful self-manufactured product lines. These were, however, exactly the product lines that competed most directly with the major luxury brands, and price competition was fierce. Yet despite that competition, Garner was quite certain that Langtry would perform well and achieve the returns she expected from the expansion investment. What troubled her was whether those returns would be sufficient to generate support for the expansion among Langtry’s board of directors. That debate, she was certain, would come down to establishing the right benchmark.

Langtry Market

Langtry had a devoted following. Products sold well both through third-party catalogs and at retail outlets (Langtry branded products had a high retail sell-through rate and often inventory was sold out at some locations). However, Langtry had already priced its goods at the highest end of offerings in each category and expected it would have to slightly lower its average prices to achieve anticipated growth. This would be accomplished by introducing new and more affordable products within established product lines without lowering the prices of Langtry’s existing flagship products.

Langtry did not enjoy the economies of scale that its competition did given Langtry’s relatively small size and local supply chain. For this reason, per-unit costs of sales were high. On the other hand, Langtry did not need to invest as heavily in marketing and distribution, so per-unit selling expenses were low, and Langtry’s reputation allowed it to charge slightly higher prices. The net result for Langtry was margins similar to industry averages. Over the last three years, Langtry realized 12% on sales after accounting for both the costs of goods sold and the company’s selling, general, and administrative expenses. The average profit margin (net income over sales) was just over 7%.

Expansion Plan

Garner had presented the expansion plan to Langtry’s board of directors at a late-spring meeting. The composition of Langtry’s board of directors reflected Langtry’s ownership. The Garner family still owned 20% of the company (Garner herself had an 8% stake), and one private equity fund, Big Sky Partners (Big Sky), held 30%. The remaining 50% was dispersed across a set of wealthy and well-connected Texas and Kansas families, none with more than a 5% stake.

No one on the board had challenged Garner’s assumptions related to the unit sales growth underlying the expansion. The board knew this industry well and was very familiar with Langtry’s success in the markets in which it planned to expand. If anything, the board believed that unit growth would be larger than anticipated. Similarly, no one had challenged Garner’s estimates related to the rather sizable investment in plant capacity. Much of that was related to increasing floor space and the purchase of standardized production equipment. All agreed that the new product offerings and their price points were acceptable and appropriate. All told, there was little disagreement on the drivers of the expansion’s cash flows and, therefore, on the cash flow forecast.

The real focus of the discussion was whether the expansion’s resulting return justified the investment. Based on the forecasted cash flows, the ROI (the internal rate of return on cash flows) was about 8.5%. Two board members had staked out opposing views as to whether this was sufficient.

Chuck Connors, a former banker who had deep roots and ties to Texas and who was a board member for a variety of businesses both large and small, was enthusiastic about the expansion. He argued that policies meant to stimulate sluggish economies had led to a sustained period of low interest rates. Even the recent interest rate increases in the United States still left rates extremely low by historic standards. As a result, many investors were searching for any and every opportunity to earn respectable returns, and by this standard, the expansion looked great. Connors said:

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