NATIONAL GYPSUM PRODUCTS CORP.

2016
On January 30, 2016, the directors of the National Gypsum Products Corporation (NGP)
met to consider methods of raising $200 million of new capital, required to finance a proposed
expansion program. This program, which would extend over the next three years, was expected
to require a total investment of about $300 million, but $100 million would be generated
internally. Thus, only $200 million would have to be raised externally. Since a major portion of
the $300 million would have to be committed, if not actually spent, during 2016 and since the
company did not wish to come to the market with a series of smaller issues during the three-year
period, the directors had decided to raise the entire $200 million at one time early in 2016. Due
to substantial fixed issue costs, it had also been decided to raise this entire amount through the
sale of a single type of security.
Mr. Sanford, financial vice president of NGP, had recommended to the board that the
required funds be raised through the sale of 6.0% sinking fund debentures to a group of five
institutional investors. He also disclosed to the board that the company's investment bankers had
suggested alternatively the sale of 2 million shares of 6.3% cumulative preferred stock at par, or
$100 per share, or the issue of 5 million shares of common stock to the public at $40.00 per
share. The investment bankers had indicated that each of these three alternatives appeared
equally feasible.
After extended discussion, in which each director took part and during which a wide
variety of views was expressed, the board adjourned without reaching a decision or even any
substantial measure of agreement. Mr. Sanford was asked to explore fully the points at dispute
and to report on his conclusions at a special meeting set for the following week.
National Gypsum Products was a large producer of gypsum and allied products with
extensive marketing operations throughout the United States and parts of Canada. In recent years
the company had added several new lines of construction materials in an attempt to diversify; a
major part of the $300 million expansion program was to be directed toward further horizontal
and vertical integration in the building materials industry.
NGP's sales and profits had increased moderately in the last decade. Basic industry
trends suggested continued future growth at a real compound rate of about 4% annually. Nearterm forecasts, however, were subject to considerable uncertainty. A number of experts believed
the business expansion after the 2008-09 recession had about run itself out and that an economic
slowdown was likely. But estimates of when another recession would begin, if at all, differed
widely, and NGP had not yet observed slackening in demand for its products.
In the absence of a recession NGP expected its earnings before interest and taxes (EBIT)
to increase 10% in 2016 to $180 million. If a recession set in before mid-year, the construction
industry would be heavily affected, and NGP's EBIT could fall to as low as $130 million or
even lower.
T his case was prepared by Professor Rocky Higgins and revised by Professor Jennifer Koski as a basis for classroom discussion rather than to illustrate an effective or ineffective handling of an administrative situation. National Gypsum Products Corporation is a fi ctional firm refl ecting the issues facing actual firms. (V. 2.0)

The vigorous expansion and diversification program on which the company had already
expended over $500 million had been entirely financed from internal sources and new borrowings.
Management had traditionally been reluctant to seek new equity capital; this policy had been
reflected in modest dividends on common stock and had, on occasion, resulted in temporary
postponements of expansion plans as funds availability ran low. The perceived need to diversify,
the attractiveness of specific projects, and the companys rising debt ratios, however, had led the
directors to accede to the urging of NGP's new president, Mr. Grant, to consider new equity
financing.
Mr. Sanford, in consultation with the company's investment bankers, had explored many
different financing methods and by the end of 2015 had narrowed the choice to the three
alternatives previously mentioned - debentures, preferred stock, and common stock. More specific
details as to each of these securities were as follows:
1. Two hundred million dollars of privately placed 20-year debentures would carry an interest rate
of 6.0% and could be sold at par value. The debentures would be retired through annual sinking
fund payments of $10 million to maturity. Legal and other expenses associated with the
placement of these securities would amount to $600,000, and the proceeds would be available
within 15 days of management's decision.
2. Two million shares of 6.3% cumulative preferred stock could be sold to the public at their par
value of $100 per share. The issue would not carry a sinking fund but could be retired in whole
or in part at the company's option at any time at a redemption price of $108 per share.
Underwriting fees would be $2 per share and other costs of issue, paid by NGP, would amount
to about $1 million. Registration and other procedures would consume about 30 days from the
time of decision to the actual underwriting and sale.
3. 5 million shares of common stock could be sold to the public at a price of $40.00 per share,
barring a major change in market conditions prior to the issue date some 45 days after the
decision. The outstanding stock, which carried no preemptive rights, had been actively traded
during January on the New York Stock Exchange in a narrow price range around $43.
Underwriting fees would be $1.75 per share, and issue costs would amount to $1.1 million.
After extensive appraisal of these three final alternatives, Mr. Sanford concluded and recommended
to the directors that the debentures would be most appropriate to the companys requirements.
First, he felt the debentures would not increase NGP's risk unduly. After issue, NGP's long-term
debt to total capital ratio would be 53%, a figure Sanford felt was reasonable. Second, at the
expected EBIT level, EPS with the debentures would be 18 cents above the comparable figure for
either common stock or preferred stock financing. Consideration of earnings per share dilution was
uppermost in Sanford's mind as he argued strongly for acceptance of the debt alternative.
A lively discussion followed Mr. Sanfords presentation. Neither Mr. Sanford nor Mr. Grant
took part in this discussion, preferring rather to listen to the views of the other directors. Mr.
Sanford, however, took detailed notes of the position taken by each director; excerpts from these
notes, in chronological order of the discussion, read as follows:
Mr. Hobbs: - Opposed to raising new capital for expansion or diversification at this time. Expects a
worldwide economic decline in 2016. Suggests that now is the time to "trim our sails" and
prepare the company to survive in an economy where many other firms are likely to fail or be
acquired.
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Ms. Zwick: - Favors use of debt to finance capital expenditures provided it has a call option.
Emphasizes her conviction that only a mild recession will occur in 2016. Stresses that even
borrowing at an interest rate of 6.0% costs "only" about 3.6% after tax. When interest rates
decline, bond prices will rise as should stock prices. Company can then call debentures and
issue stock at a more reasonable price.
Mr. Dexter: - Seriously questions the use of added debt. Building materials field is highly
competitive and subject to significant cyclical swings. Business risk is high enough without
additional financial risk through more leverage. Stockholders have a right to protect their
investment from the risk of ruin which high debt ratios always imply, should the demand for
NGP's products decline. Suggests that leverage leads to undesirable fluctuations in earnings,
which could lead to greater volatility in market price of the common stock. Emphasizes that
the company's price to earnings ratio and stock value could be jeopardized by increased
volatility in earnings per share. Favors the use of common stock. Feels that the current price
to earnings ratio only appears low relative to past highs, which are not really relevant to the
current financing decision. Believes that use of debt financing now would make it virtually
impossible to raise additional debt for quite some time. Future external capital needs would
then have to be met by equity, historically a very fickle, source of capital.
Ms. Leonardson: - Favors debt financing. Thinks NGP may be vulnerable to a hostile tender offer,
believes our failure to take full advantage of the tax shields created by debt financing will
keep stock price down inviting attack by more financially astute raiders.
Mr. Tomich: - Favors equity on a cost basis. Dividends on common stock are the only "cash cost."
At a dividend of $1.25 per share, the annual cost of the equity is only 3.13% ($1.25 per share
X 5 million shares/$200 million). Interest on the new debentures would be $12 million, and
the sinking fund of $10 million would mean a total cash drain of $22 million, or 11.0%.
Mr. Salomon: - Thinks the 2016-2020 period will see the recurrence of high inflation and that "net
debtors" have advantages under inflation because of repayment in "cheaper" dollars. Feels
we should learn from experience with inflation in South America and Europe, where much
higher debt ratios are common in many corporations. The 6.0% interest rate only appears
high by U.S. standards; in many countries, interest rates are far higher and companies
continue to borrow. Feels the timing on a stock issue is bad. Ultimately, the stock market
will be seen as an "inflation hedge", and stock prices will rise considerably.
Ms. Edstam: - Favors preferred stock, quite concerned about future sales and EBIT. Total cash drain
of preferred is less than debt when sinking fund is included. On the upside, preferred stock
looks better than new common because dilution is considerably less. On the downside, with
low or negative EBIT, high debt might mean financial disaster. Whereas preferred dividends
could be passed. The flexibility of preferred stock under highly favorable or unfavorable
conditions makes up for the tax disadvantage of preferred relative to debt.
Uponthissuggestion,considerableargumentarose.Ms.Zwicksaidthatuseofthemost
expensiveformofcapitalwasnotherideaofacompromise.Mr.Dextersaidthatsincethe
companywouldnomorethinkofeverpassingapreferreddividendthanitwouldofdefaultingon
debentureinterestpayments,hecouldthinkofpreferredonlyas"abondwithataxdisadvantage."
Since it was obvious that the discussion was becoming more and more emotional and would
probably not result in any rational conclusions, Mr. Grant, the president, suggested that it might be
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premature to press for a final decision at this time, particularly in view of the many approaches
which had been expressed. It was already well after the time of the social hour which customarily
followed directors meetings, and Mr. Grant suggested that the meeting be adjourned to the
following week, at which time Mr. Sanford, the treasurer, would attempt to resolve the conflict
which had been so evident.

Exhibit 1
NATIONAL GYPSUM PRODUCTS CORPORATION
Balance Sheet on December 31, 2015
(000,000 omitted)

Average interest rate equals to 7.25%. Annual sinking fund payments 2015-2018 equal $28
million.

Exhibit 2
NATIONAL GYPSUM PRODUCTS CORPORATION
Summary Sales and Income Data
Years Ended December 31, 2002 - 2015
(000,000 omitted)

In 2015 the company's marginal tax rate, including state and local taxes, was 40%.

Exhibit 3
NATIONAL GYPSUM PRODUCTS CORPORATION
Selected Common Stock Data
Years 2001 to 2015, 2016 to January 29

Estimated based on 30 million shares currently outstanding and ignoring costs of the new
financing.