This paper would discuss the present financial condition of the two companies those are willing to be merged. The paper along analyzes their cash flow and debt equity ratio to making decision of merging by LEI with Shang-Wa. It should be evaluated first by analyzing the situation, develop end state goals, find out alternative solution, and lastly evaluate the solution with an implementing the plan. These terms are considered and evaluated in terms of financing way out and protection of Lester Electronics Inc. by merging with Shang-Wa Electronics. The intention of the research is to find out the financial solution which faced by Lester Electronics before and after merging with Shang-Wa Electronics and to accomplish the solution of the problem. LEI and Shang-Wa are also friendly business partners, can also merge their companies, which would protect LEI from less revenue and Shang-Wa from taking over by others. LEI have been motivated to expand the distribution in the USA.
Particularly, there are nine main factors considered to be analyzed in this research paper: first, the concept of situation analysis of these two companies; second, the problem report of Lester Electronics; third, end state goal of Lester Electronics; fourth, financial alternative solutions of the problems in LEI; fifth, analysis of alternative solutions of the problems in LEI; sixth, risk evaluation and Improvement Techniques of LEI; seventh, most advantageous solution of LEI; eighth, implementation plan of LEI; and at last, ninth part, the evaluation of results of LEI. It should be concerned about having the financial capacity to merge with Shang-Wa. The cash flows of the company should be evaluated with the existing debt in Shang-Wa aimed to increase shareholder’s wealth.
With a brand popularity of ‘Lester’ the Lester Electronics Inc. (LEI) is an US distributor of consumer and industrial electronic components such as capacitor in the US market. The Korean based manufacturer Shang-Wa Electronics is the exclusive supplier of LEI for US market. With continuous support from Shang-Wa, LEI has been growing its market share in an increasing for last few decades. In 2004 Shang-Wa fall in financial crisis for which it was going to be taken over by another Korean electronic company and that is Transnational Electronics Corporation. Both the companies LEI and Shang-Wa were upset with their company position. LEI would be in a threat of losing brand position and large market share with out the support of a supplier like Shang-Wa. At the same time CEO of Shang-Wa has to go in retirement after the take over. To overcome these crises both the company thinks about merger or joint venture. To become successful in end state goal, which is to being successful in merging with Shang-Wa, LEI has to measure the progress and success of the purchase of Shang-Wa. For this, it also has to focus on long term debt with equity mix of the company. LEI also have to focus on future by accepting benchmarking within the works of other company, to accomplish its end state goals. LEI can analyze other alternatives in its business, by choosing the perfect metric. In the part of risk assessment, LEI should determine the significance of risks, associated risks, consequences of risks, and the potentiality with the worth of the risks. As an alternative solution, LEI and Shang-Wa can develop a partnership business. (University of Phoenix, 2007)
At the time of the negotiation in 2004 Lester’s Total liabilities and shareholders’ equity was 252,948.50. Where capital surplus 146,280 thousand, Retained earning 15,315.50 thousand, common stock 104 and Total Liabilities 91,249.00. Within this period Sang-wa’s total liabilities and shareholders’ equity 142,292.70 that includes retained earnings 29,496.75, Capital surplus 6,827.00 Common stock 91.00 and total liabilities 105,877.95. Within the same period the probable take over company Transnational Electronics Corporation (TEC) has a total liabilities and shareholders’ equity 3,675,893 that includes Capital surplus 497,249, retained earnings 92,681, Common stock 119,431 and total liabilities 2,966,532. The situational analysis implies that TEC is far stronger then LEI and Shang-wa and if TEC take over Shang-wa then Lester would lose 43% of their revenues. Thus it is most significant for LEI to justify the merger with Shang-wa to increase shareholder’s wealth.
Identification of Issues and Opportunities of Lester Electronics Inc.
Financial cost of distress
An important issue of Lester Electronics Inc. must consider that, the company is going to face expensive financial distress costs after acquisition with the Shang-Wa. The potential costs of financial distress can be so much debt for the firm. Lester is in enough good in position not to face financial distress like bankruptcy. But it can obviously face some indirect costs, like losing confidence of customers and efficiency in financial position before pre-merger days. Customers loose their confidence because before merge with Shang-Wa, Lester had.01 debt-equity ratio in 2004, whereas, Shang-Wa has 0.42 debt-equity ratio. They obviously feel uncertain in financial security before they have. Lester can highlight the issue as an opportunity that, this higher debt equity ratio is only for short term after the acquisition is made with Shang-Wa.
Risk of Stockholders
The other issue, which can be faced by Lester, is reducing the risk of the stockholders of the company. To merge with another fully financial risky company, stockholders and investors feel insecure. By resolving the issue, LEI is having the opportunity to increase stockholders’ wealth and company’s value.
Stakeholder Perception on Ethical Situation about the Company
The stakeholders of the two companies are shareholders, investors, employees, customers, and also both Mr. Lin and Mr. Lester. The rights of the shareholders are getting a good return from their investments. LEI publicly reports to Security Exchange Commission (SEC) about all earnings and investment activities information. The Earning per Share (EPS) are most viewed ratio of the company.
The Employees and Customers
The next groups of stakeholders are companies’ employees and customers, which is the largest groups of people. The employees have the right to get equitable treatment in the merger process. The companies must ensure that the employees should be in guaranteed positions in the company or having a fair treatment package. The customers have also the right to get high quality products in reasonable price.
Problem Report of Lester Electronics Inc.
The future business opportunity of Lester Electronics should be developing new manufacturing opportunities, which will achieve its goal. In the problem report, there are two parts should be considered: first, to compare the internal strategies of merger and acquisition in the growth of company’s revenue. Lastly the company must finding out the most effective strategies from the situation analysis. In the part of internal strategies, Lester should approve some decisions. These decisions have to solve questions, such as financial plan, new markets targeted with mergers, change in capital structure, and change in financial strategies. (Pandey, I. M. 2007)
Financial Planning of LEI
Financial plan of any company consists with three major issues, which are forecasting, budgeting and controls. Forecasting means the short term and long term forecast of the company for long lasting period of time. Short term planning is the company’s outlook, basics of customers and patterns of the company in the future¸ which are the major influences on expenses and income. Long term financing is constant in adjusting the company in the top of the changes in the markets.
Budget is a financial decision made by the company for future. There are mainly three types budgets, they are, the capital budget, which is estimating the fixed and capital assets of the company. The cash flow budget is made for the continuing cash flows should be available in the company. Debt Budget is another budget, to make sure the future availability of company’s revenues for the debtors of the company. It is an important factor, control, in financial planning. It can be an outcome of an underlying conflict between the interests of existing managers and of shareholders. (Wood & Sangster 1999)
New Target Market with Merging
In the merging decisions, Lester should first consider the enough financial capacity with merging Shang-Wa. In the evaluation process of new market segments, the company first should consider that, whether the merger is accepted by the previous customers of the company. The company should also consider the view point of new customers about merging decisions of the company.
Change in Capital Structure
By merging with Shang-Wa, the Lester has to change its capital structure. There are some changes which occurred: first, the taxation form of the company; second, the calculation of Net Present Value of the company; third, the value of stockholders; fourth, legal effects of counting assets after merging; lastly, value involves in stockholders, also considered as total value of the company.
Change in financial Strategies
There are also occurring some financial strategies in acquisition, such as benefits from acquisition in finance, to analysis the total values of the firm, and using defensive tactics includes pills, greenmails etc.
The Lester Electronics Company also has to find out the most effective strategies from the situation analysis in the problem statement. The current situation shows that, Shang-Wa can not avoid TEC to takeover. For that, LEI has to face a loss in next five years. In addition, we can see that, Avral Electronics is interested in acquiring with LEI. So, LEI should take some actions to become less attractive Avral, and should protect its cash flows from acquisition with Shang-Wa. Both of the two problem solutions can be used in purchasing Shang-Wa by LEI. This purchase will create long-term debt, which is less attractive for Avral, and also will protect Shang-Wa from TEC
End-State Goal of LEI
Lester Electronics Inc.’s vision is to being the leader of manufacturing capacitors. This would be possible by having a joint venture with Shang-Wa Electronics. It will be the ultimate vision of LEI. It will allow LEI to increment its revenues by 43% within next five years, and to increase its customers by 20% within a year, and also to add various products in its product line in six months. In the state vision of the LEI, it will acquire strong management team, high knowledge of maximizing shareholders wealth and a powerful leader in Bernard Lester.
To become successful in end state goal, LEI has to measure the progress and success of the purchase with Shang-Wa. For this, it also has to focus on long term debt with equity mix of the company. First, it should consider the required cash in capital expenditure. The company’s capital structure represents the portion of company’s current and long term debt and equity.
LEI and Shang-Wa should calculate long term debt to equity ratio of them for two years. By these, they can learn their capital structure. First LEI can develop the problem solving model to know the company’s future opportunities in finance with the initial purchase of Shang-Wa. Other functions of the model can also identify risks, benefits and alternatives to achieve the end state goal of LEI.
Financial Alternative Solutions of the Problems in LEI
As an alternative explanation for the problem with merging LEI and Shang-Wa, they could think about to being in an outward appearance of partnership, where they can share profit loss and control their companies extremely well. A partnership business is a dealing, where two or more persons can manage and activate their business with having reasonable and personal liability for the debts of that business. Even some massive business companies acquire the decision of partnership. For an example, Microsoft coupled in partnership with Novell. The executives’ of these companies are revolving from competition to cooperation, because their customers need the mix together of their technologies. The result of their partnership has increased the profit of Novell up to 16%. It also benefits the customers, who are satisfied with Microsoft products.
LEI have the benefits of financial alternatives benchmarking from the collection of data, which can assist the company to analyze the alternatives with goals. Company grows usually with existing departments by capital budgeting activities. This can also be possible from mergers. The primary motivation of merger is to provide opportunities which bring together for increment the value of both companies. There are some tools used in benchmarking, like, identifying, understanding and adapting best practices from other company. Benchmarking is a process which gives the ability to look forward for finding best for the company. As LEI has taken the right decision of doing merge with Shang-Wa, by reviewing the concepts of the weighted average cost of capital (WACC), operating leverage, Beta, financial mix, dividend policy, and financial risks policy of both of the companies. (Pandey, I. M. 2007)
Analysis of Alternative Solutions of the Problems in LEI
LEI have considered several factors to be considered in finding a solution. Stakeholders’ perception is most important to be analyzed. The solution of customers like retention, satisfaction, incremental time, intensive security of research should be ensured while merging. To identify and evaluate the risks and situation is also needed. There are some lists of major alternatives are discussed briefly in below:
Constant Satisfaction of Customers and Shareholders
The company, LEI should keep the satisfaction of customers and shareholders in a continue process. The sacrifice of quality of the products of the customers should not be considered. The shareholders also ensure the good amount of return from their investments to the company.
Ensuring NPV > 0 for the Ultimate Solution
The value of the investment of shareholders to LEI after deducting all benefits and costs is called net present value. So, we can say that, net present value is the future cash flow from customers minus costs of investments by shareholders. LEI should always concern about that, NPV should not go beyond the level of negativity.
LEI Always Keep Profitable
LEI should always keep the promise of being profitable to its stakeholders, even after merging. From the income statement of the LEI, we can see that, it always keep the net profit higher in the next year, like in year 2002 the net profit was $6707, in 2003 it was 14718, and in 2004 it became 30010. So, the stakeholders of LEI can expect the same results after merging with Shang-Wa.
Issue and Opportunity Identification
Ross, S and et al, (2005) argued that in the determination of risks, the probability metric is perfect for partnership business. LEI can use NPV to evaluate business and its situation for partnership. There are some advantages in NPV, which are:
NPV to evaluate measurement is a comprehensive and widely used to decide the substantiality of a project. There are also some disadvantages includes in NPV, including soft data like, market forecasts complexity involved in the calculation. For it LEI it required enhancements to hold risk decisions (NPV > 0 = Profitable. NPV < 0 = Unprofitable)
ROR evaluate also provides another advantages of IRR that are easily understandable and intuitive meaning by considering time value of money with ignoring of other risks. There are some disadvantages related with IRR, like tedious to calculate (but easier than NPV), fail to make out the unstable size of investments Internal Rate of Return is another metric to be considered in the establishments of the LEI project and its related factors. Internal Rate of Return is another metric to be considered in the establishments of the LEI project and its related factors.
Profitability Index (PI) is estimation that applied to provide some advantages like produce concise number in project ranking and optimize the utilization of capital. The application of IRR is related to disadvantages like not intuitive and used for ranking projects only to putting weight on available cash only, not in available resources. The analysis of alternatives are its business with each risk assessment; to determine the importance, associated risks, consequences of risks, and the potentiality with the worth of the risks. LEI have to focus on future by accepting benchmarking with in the works of other company, to accomplish its end state goals. By choosing the perfect metric, LEI can analyze other alternatives in its business. In each risk assessment, LEI should determine the importance, associated risks, consequences of risks, and the potentiality with the worth of the risks.
Risk Evaluation and Improvement Techniques of LEI
The alternative solution, risks and probability, consequence and severity as well as mitigation techniques are also significant to risk evaluation of LEI. Changes in economical condition related with credit risk, default risk, country risk and liquidity risk. LEI deal with credit, market, liquidity, operational, business, and legal as well as reputation risk. Legal structure, risk and capital are closely aligned with the structure of the group divisions and are independent. The risk management is same for all group divisions.
The investment in different securities or projects may fall due or may be default as a consequence of Credit risk and the mitigation technique is maintaining good credit rating. Country risk affects on investment in different region may expose risk due to political, sociological, and economical changes and mitigation techniques are managing country risk rating exposed. The changes in interest rate, stakeholders’ position, and Exchange rate and Commodity price increase risk or decrease the expected return of investment brings as a result of market risk. However, market alternation is used as a Mitigation Techniques.
Business risk: The Business risk can be aroused due to client behavior, market environment and technological changes. Strategic analysis & economic model gets the most priority for LEI. Interest rate risk: The changes in interest rate risk increase or decrease the expected return of investment. Maintaining good Return on Investment (ROI) rating provides faculty of overcoming Interest rate risk.
Most Advantageous Solution of LEI
When LEI can narrow all alternatives in a final and best solution, they can also solve the risks associated with the plan for mitigation. The mitigation can consider the ensured solution which is developed and implemented in the problem solving model. The Risk mitigation of LEI is described below:
Firstly partners are liable for the company debts and liabilities in personal. When partnership is unable to meet in financial obligations, LEI should use its personal assets to pay the debtors of the company. Secondly partnership business can reduce the lawsuit worries by a good insurance policy. Thirdly the acts of one partner in business are binding legally to others and out of the rules; there is no act in partnership disputes. Moreover the partnership business should build up within complete trust, which LEI has on Shang-Wa up to 35 years. Thus to develop a partnership business, LEI and Shang-Wa should prepare a written agreement of partnership, where, each partner must promise to share profits and losses, day to day duties and the consequences if any partner died or retired.
Implementation Plan of LEI
Smith, L. M., (2007) argued that in the stage of implementing plan, LEI should plan the groundwork for implement the proper solution. The last solution between LEI and Shang-Wa, they have to create and implement a plan with their partner. There are three important steps have to be fulfilled in the implementation plan, including:
Consultation with Partnership Expert
The sensible first step relates with implementation plan is to consult with partnership expert. External consultant can provides critical business decisions on law of employment, includes contracts, recruiting, discriminating, beneficiary and time limits in working. An expert can also help in addressing the HR aspects of partnership like unique issues in employment in partnership.
Construction of Framework
In the next step, LEI needs to be developing a framework, which can construct a successful relation within partners in their working time. Mostly, a joint venture company also does same activities but in the boundaries of corporate framework.
Develop a Concept Plan
Lastly, LEI can be benefited by developing a concept plan with Shang-Wa, which will be a continuous process of regular plan judgment in a partnership business.
Evaluation of Results of LEI
In every joint venture company, there are some basic terms should be evaluated, these are:
- Sensible Business: When a partnership business is going to be formed, it must have the diligence and sense of making surety that, it is sensible business.
- Potentiality of Selected Partner: It is also obvious that, the selected partner for the business should understand the business and the market very well.
- Sensible Business Model: In the improvement of business model, the new model of the business in partnership should make sense in analyzing the critical business environment.
When a business model is developed, it can be formed easily, but it is also difficult to get out from the relationship. In the assessment of results for LEI and Shang-Wa, the operational success in concept of economics, competition and external customer relations with strategies, and working relationship and behavior of stakeholders are also important.
From this research paper, LEI can scrutinize the alternatives, valuable solution, analyze and mitigate risk, and also implement a strategy for the successful partnership business with Shang-Wa. If these two companies come to in a partnership business, the regular and strong cash flows can maximize the wealth of shareholders. It can prevent LEI from the loss of revenues and Shang-Wa from takeover by other companies. The end result of this research is not only to form of successful partnership, but also maximize shareholders wealth as a smart financial decision taking by these two respective companies: LEI and Shang-Wa Electronics.
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