Problem_Solution_Lester_Electronics

Running head: PROBLEM SOLUTION: LESTER ELECTRONICS Problem Solution: Lester Electronics Anna Barranco University of Phoenix Problem Solution: Lester Electronics In the Lester Electronics scenario the owner of Shang-wa has decided to sell their business to Transnational Electronics Corporation (TEC). Before the decision is made to merge with another company there needs to be considerable research, negotiating, and benchmarking done to ensure that the merger is a good business decision. With any business acquisition there come risks. Projections about the future of how well the company will do along with determining whether or not the business will make the type of money to increase the wealth of the shareholders are inherited risks. Financial compensation for the shareholders will come in the way of shares or dividends. Financing new projects such as the Shang-wa acquisition requires the business owners to look at the debt and equity of the organization. The business leaders will look at the number of assets along with the company’s history of productivity and competition. If the product is in demand, after looking at the potential of the company, and all considerations have been made, it may be a good business decision to purchase or merge with another company. There will be discussion surrounding the merger between Shang-wa Electronics and TEC. This merger may leave Lester Electronics in a position in which the company is not able to survive. In this paper the scenario and benchmarking surrounding the scenario will be discussed. In addition the weighted average cost of capital, capital structure mix, investment risks, and dividend policy on wealth maximization will be also be included in the discussion of this paper. Number of mergers keeps growing, originally this strategy was primary seen in US, now is spreading worldwide and becoming the most important business growth strategy of this millennium. Daily business news brings information about mergers and acquisitions and provides the potential investors with details of the deal including information about capital structure of the newly created business entity. Lester Electronics, Inc. (LEI) similar to all successful businesses is faced with merger and acquisition of its major supplier. LEI decided to buy out Shang-wa Electronics and the management is evaluating all possible options of raising capital to finance the merger, mainly concentrating on two most popular alternatives one using debt or the other equity (University of Phoenix, 200) Situation Analysis Issue and Opportunity Identification For many small business owners, the prime sources of capital to start, sustain or expend a business are loans from debt financers such as banks and credit unions. This form of financing can be preferred method for the small business owner as they still retain of the equity in the company. The owner still can make all business decision and collects business profits. In addition debt offers tax benefits therefore, it maximizes business returns. Lester Electronic needs to decide on the most appropriate financing to finalize the merger with Shang-wa Electronics. Financial institutions offer various ways to finance mergers and acquisition by using debt. “In general, a firm can choose among many alternative capital structures. It can issue a large amount of debt or it can issue very little debt. It can issue floating-rate preferred stock, warrants, convertible bonds, caps, and callers. It can arrange lease financing, bond swaps, and forward contracts. Because the number of instruments is so large, the variations in capital structures are endless.” (Ross, Westerfield, & Jaffe, 2008) If the capital structure has high ratio of debt versus equity this may create pressure on the business as it increases the obligation due to interest and principle that have to be paid. If the company is going through slow down of a business these debt obligations create financial risk. “The ultimate distress is bankruptcy, where ownership of the firm’s assets is legally transferred from the stockholders to the bondholders. These debt obligations are fundamentally different from stock obligations. While stockholders like and expect dividends, they are not legally entitled to dividends in the way bondholders are legally entitled to interest and principal payments. (Ross, Westerfield, & Jaffe, 2008). For purpose of this analysis LEI will limit the available options to only common stock and debt. LEI can finance a buyout by borrowing money based on the business value and assets of the company. Mergers are also frequently financed using equity such as issuing new stock or by stock swaps. Equity financing offers many benefits for small business that are in need of raising capital for future growth or as in LEI scenario for mergers and acquisitions as they can attract investors by projecting high growth and good returns on investment. LEI will only need to repay investors if the business is profitable. One other option that can be considered or even recommended is for the owner of the business to contribute in a form of investment. Many outside investors will not want to risk their money if the owner is not willing to take the risk by putting his own funds into the business. One of the disadvantages with equity financing is that it can dilute the ownership of the company for the shareholders. Another, that depending on company future performance the share of profit can be value higher than if the company paid the interest on a loan. In addition, by using equity financing owner gives up sole control of the business as equity investors have right to be involve in the decision making process and activities of the company. Issue and Opportunity Identification LEI is facing potential overtake of Shang –wa by TEC. LEI’s 43 % of revenue in the future is plan based on existing business relation with Shang-wa so this situation presents high risk for future growth as planned. On other hand, John Lin, founder and CEO of Shang –wa made it known that he is interested in retiring soon and would like to partner with LEI. Another issue arises due to another potential acquisition this time LEI was approached by Avral, large corporation with global presents that is seeking to expend its assest. The latest proposal could mean a lot of changes the way the business is run currently. As a result Bernard Lester is concern with future of LEI and Shang-wa as these businesses depend on each other for future growth. Both owners wish to protect their respective companies from takeovers or acquisitions. Opportunity Identification These two companies are facing issues related to different future for either of the business but these two owners could change these issues into opportunities. If LEI and Shang-wa merge together they would avoid the takeover by TEC or Avral but instead focused on what these two companies have been going well in the last years and use this time to secure their future position in the market. A company will sometimes engage in a defensive acquisition strategy by purchasing smaller firms that are in the same business. By acquiring these firms, the company protects itself from takeovers from other companies, which, as a result of antitrust laws, may not be able to merge with the enlarged company without creating a monopoly (investopedia.com, 2006). Stakeholder Perspectives/Ethical Dilemmas Compelling values and interests play important role in relation to the decisions made by Lester Electronics’ management team to buy out Shang-wa that will affect the stakeholders. The employees are stakeholders, in this scenario, because they provide the vitality of the organization and contribute in the product success. Employees are more concerned with job security; mergers can create some opportunities for professional growth but also may eliminate some duplicate positions. Employees often fear the layoffs due to merger; as a result employees may experience low morale. Another group of stakeholders, in this scenario, includes the management responsible to make profits for the organization and managing daily operation. This group also will face changes created by the merger. “Managers should choose the capital structure that they believe will have the highest firm value because this capital structure will be most beneficial to the firm’s stockholders.” (Ross, Westerfield, & Jaffe, 2008) The merger will also bring changes to Board of Directors and in similar situations some power struggle should be expected as the new board members may want to control the company. The customers are also stakeholder because they will be investing into a product and getting the most gain or failure once investing. The board members as well as stockholder of the organization are stakeholders, since they invested money upfront and they might face also ethical dilemmas. Their goal is helping the company make the right decisions that will lead to their success. Most of them hold stocks in the company and will therefore; want what is best for the organization. They are mostly concerned with the company being able to use the merger for future growth. This might be a form of ethical dilemma when the final capital will be selected and some board members might disagree with the decision. Considering these problems that might arise from the stakeholders’ perspectives, LEI needs to focus on addressing the issues, while still focusing on the available opportunities for the company. Problem Statement By analyzing financial statements and current business proposal, in order to improve LEI’s situation the company needs to move forward with Shang-wa acquisition and in the process protect the future cash inflow. The company will increase debt finance due to payment for Shang-wa and as a result the LEI’s NPV will become less attractive for Avral to purchase the company. The LEI and Shang-wa merger will create “win-win” scenario for these companies and protect them for now from hostile or friendly takeover by another interested party. End-State Vision The ideal end-state for Lester Electronics looks very bright due to buyout of Shang-wa, both companies have done business together for many years, so this transition should not be difficult. By evaluating available financing options LEI will be in position to arrive at the most beneficial outcome. Deciding on the best capital structure will benefit the company in long term. The synergies of these two businesses should provide many opportunities for future business growth. As a result of this merger the company will increases market share by initially maintaining a strong relationship with existing customers as well gaining new clientele. LEI will also focus resolving any problems that may come to light due to the merger and conflicting interest from company’s stakeholders. By perusing this merger with Shang-Wa LEI is positioning the company as a stronger company, which may avoid future hostile takeover by other companies in the industry. Alternative Solutions Before making a business merger management needs to assess the benefits of taking on an acquisition that may in the long-term costs the stakeholders a considerable amount of money or create substantial loss. Companies are aware of the potential risks that they may be taking on when they partner with another business. Risks to consider include profit losses leading to the company closing or filing bankruptcy. Another risk that may lead the company in the direction of a negative outcome may occur when a drastic change in the pricing of the product causes a significant amount of loss. Other potential risks include the company not having enough assets; therefore, they are not able to get the financing needed for the investment to work. If the research and benchmarking is not done thoroughly, the potential to get involved in a company in which no profits are made and huge risks cost the stakeholders money increases. The product and the marketing of the product can determine what the risks are present and threatening as a large liability. Without there being a market for the product, there will be no growth and risks will mount. Other factors which influence the rate of return include an inflation premium or a risk premium. The inflation premium and the risk premium make up for the costs associated with an increase in the economy and the risks associated with investments. According to HSBC (2008), “Bonds are negotiable debt instruments issued in bearer or registered form by a company or a government body to creditors and whose par value at issuance represents a fraction of the total amount of the debt. The duration of the debt as well as the terms and conditions of repayment are determined in advance. Insolvency risk: the issuer may become temporarily or permanently insolvent, resulting in its incapacity to repay the interest or redeem the bond. The solvency of an issuer may change due to one or more of a range of factors including the issuing company, the issuer’s economic sector or the political and economic status of the countries concerned. The deterioration of the issuer’s solvency will influence the price of the securities that it issues. Interest rate risk: uncertainty concerning interest rate movements means that purchasers of fixed-rate securities carry the risk of a fall in the prices of the securities if interest rates rise. The longer the duration of the loan and the lower the interest rate, the higher a bond‘s sensitivity” When purchasing a bond, the yield to maturity is good to know. Understanding that the yield to maturity allows the purchaser to know what to expect as the rate of return on the bond is an important factor to make the best decision related to investments. By taking into account the current price of the bond and the interest rates, the investor can have an idea on whether or not the investment is expected to have a good return. Dividends can have a significant impact on wealth maximization. Dividends are used to determine the present value of a firm’s common stock. Investors believe the value of the firm’s common stock is equal to the present value of all the expected future dividends. Paying out dividends to investors may not always be the optimal decision to maximize wealth. Many firms have the opportunity for growth, by retaining the dividend and using it to invest back into the organization the firm is also maximizing wealth. One disadvantage that corporations encounter when paying out dividends to investors is double taxation. The organization pays income tax on the corporate income then the investors must pay a personal income tax on the dividend that is received. Dividends also have an effect on the accounting value of stockholder’s equity. When a firm retains part of its earnings instead of paying them out as dividends the organization’s stockholder’s equity increases (Ross, Westerfield, Jaffe, 2004). One alternative solution for LEI and Shang-wa is to form a business partnership in which both owners become co-owners and they share future profit or loss. LEI will benefit from the collection of benchmarking data because it will assist them as they identify and analyze alternatives to associate with each goal. In this manner, the best measure of the end-goal can be assessed. Analysis of Alternative Solutions LEI must consider several factors when proceeding with a solution. Each stakeholder’s perspective must be carefully analyzed. Customer retention, satisfaction, and base-increase all require time and research-intensive scrutiny to ensure the solution is being executed properly. An appropriate timeline for a major transformation needs to be established. Risks and consequences need identification and evaluation. Essentially, LEI still has some critical analysis to cover before this transformation will be successfully implemented throughout the organization. Several alternative solutions can be categorized as unimportant or minimally important in achieving LEI end-goals. LEI should eliminate the alternatives having consequences that have been determined unworthy of the risks. Rationalization of this decision includes the following criteria: (a) continuous satisfaction of customers and shareholders, (b) ensuring NPV > 0 regardless of solution, and (c) LEI remains profitable. After generating the goals for Lester Electronics, the goal that was weighted the most was to restore customer and employee loyalty. Reason why this goal was weighted a five was due to the LEI desire to acquire Shang-wa, what translates to potential loss of existing customers as they may feel adverse about the merger. Customers and employees loyalty needs to be focused on by Lester Electronics and Shang-was especially in the initial steps if they are to succeed. Without the loyalty of the customers, no increase of sales would occur and all other plans to go global would have to be put on hold. Moreover, restoring employee loyalty is a key factor when developing a global position in the market. As a result of the customer and employee loyalty, the ability to increase sales and revenue is the next most weighted goal. The direct result of loyalty can be shown in an increase of sales due to the customers and employees understanding of how the company wants to position itself in the market. This can allow the customer and employee the ability to make good decisions for the company. Thus, the next weighted goal of establishing global products and services is a byproduct of strong customer loyalty and increasing sales. Loyal customers will drive sales which would create an environment to generate new products and services that can be cost effective and efficient. Finally, from these three goals the end result would be an increase in shareholder value for the company. Shareholders will be able to see strong customer and employee loyalty which create innovative products and would drive sales. As a result of these sales, shareholder value could increase substantially by creating a solid foundation for the company. Risk Assessment and Mitigation Techniques Certain risks are present when determining which profitability metric is appropriate for the partnership project. NPV will help LEI evaluate the business case for partnership, and the advantages of NPV include: · It is fairly comprehensive · It is widely used · It enables easy decisions (NPV > 0 = Profitable. NPV < 0 = Unprofitable) Disadvantages of relying on NPV include: · It depends on soft data such as market forecasts · There is some complexity involved in its calculation · It needs enhancements to accommodate risk The IRR is another metric to consider when establishing the project and its priorities. Advantages of IRR include: · It is easily understood and has intuitive meaning · It considers time value of money but ignores other risks Disadvantages of relying on IRR include: · It can be tedious to calculate (but no more difficult than NPV) · It fails to recognize the varying size of investments in competing projects A third metric to consider is the PI, which equals NPV divided by Initial Investment. Advantages to applying this metric include: · It produces a concise number for project ranking · It optimizes utilization of capital (important if cash is scarce) Disadvantages of applying PI include: · It is not intuitive, and can only be used for ranking projects · It puts weight on available cash, rather than available resources As discussed, benchmarking has allowed LEI to see what has worked for other corporations, and whether their alternatives align with the end-state goals that LEI sees as their future-focus. Once reasonable metrics are chosen, LEI can further analyze each alternative; determine level of importance, the risks associated with each alternative, the consequences of the risks, and whether or not the potential consequences are worth the risks involved. · All partners are personally liable for business debts and liabilities · If the partnership is unable to meet its financial obligations, LEI may have to use its personal assets to pay off debtors · A good insurance policy can do much to reduce lawsuit worries within partnerships · Business-related acts of one partner legally bind all others · There is no Act that exists which sets out rules for settling partnership disputes · It is essential that LEI go into business with Shang-wa with complete trust · LEI and Shang-wa must prepare a written partnership agreement establishing, among other things, each partner's share of profits or losses, day-to-day duties and what happens if one partner dies or retires( inc,1999) Optimal Solution Once LEI has narrowed all alternatives to an optimal solution, they will need to develop a plan for mitigation of risk associated with the solution. This will ensure that the solution can be developed and implemented in the final steps of the problem-solving model. The table below illustrates potential risks associated with partnership and plans for mitigation. Implementation Plan LEI is now in a position to begin laying the groundwork for plan implementation. The optimal solution has been determined to be partnership of LEI and Shang-wa; however, neither Bernard Lester nor John Lin has experience to create and implement a plan to partner with another company. Therefore, a sensible first-step would be to consult with a partnership expert. An external consultant can help LEI and Shang-wa establish critical business decisions such as: practical information on all aspects of employment law, including contracts, recruitment, discrimination, employee benefits and working time regulations. Additionally, an external expert can help address the Human Resources aspects the partnership will encounter such as the employment issues unique to those working in a partnership. LEI will also need to determine what kind of framework they will construct for a successful working relationship as a partner rather than an individual proprietor. Generally, a joint venture corporation involves the same type of activity as above but within a corporate framework. Finally, LEI would benefit by coordinating with Shang-wa to produce a scoping document or concept plan, as well as an ongoing assessment of the success of the partnership in the form of regular plan evaluations Evaluation of Results Every joint venture needs to consider few elements of future business such as would the co-owner be a good partner for the business' Does the business model will bring a success' When a potential joint venture partner approaches a business, the business must exercise care in its due diligence to make sure the partnership makes sense for the business. It is absolutely necessary that the business understands who the potential partner is and what the industry is all about, which makes preliminary environmental scans critical. How would be the new company engage in doing business in the future' It can be very easy to get into a new business relationship but very difficult to resolve. Conclusion This paper scans alternatives, defines optimal solutions, analyzes and mitigates risk, and outlines an implementation plan for the successful partnership of LEI and Shang-wa. Shareholder wealth will come to both organizations in the form of stronger cash flows as a direct output of the partnership: a partnership will prevent revenue loss for LEI, and will prevent the takeover (and potential demise) of Shang-wa. Therefore, the end-state is not only successful partnership; maximized shareholder wealth will also be realized if smart financial decisions continue on behalf of both leaders of each respective company. Lester Electronics needs to continue working to establish the most beneficial capital structure for this type of business in order to merge successfully with Shanga-wa and meet the expectation of the shareholders by maximizing the company wealth. LEI should evaluate presented solutions and alternatives and arrive with decision that will provide substantial economical gains for the future company. References Asia Pacific Journal of Management. Volume 18, Number 1 / March, 2001. Pp. 101-111. Retrieved April 26, 2009 from www.springerlink.com. Defensive Acquisition. (2006) Retrieved April 25, 2009 from http://www.investopedia.com/terms. Investopedia (2006). Evaluating A Company’s Capital Structure. Retrieved April 18, 2009, from http://www.investopedia.com/articles/basics/06/capitalstructure.asp HSBC. (2008). Notice in Relation to Designated Investments. Retrieved April 18, 2009, from http://www.hsbc.cz Kathman, David. (2002). Why Discount Rates Matter. Retrieved April 18, 2009 from http://news.morningstar.com/articlenet/article.aspx'id=84699&_QSBPA=Y Knowledge at Wharton. (2006). Leveraging Risk Management. Retrieved April 18, 2009, from http://knowledge.wharton.upenn.edu/article.cfm'articleid=1383 Partnership: Advantages and Disadvantages (1999). Retrieved April 26, 2009 from http://www.law.cornell.edu/wex/index.php/Joint_venture. University of Phoenix. (2004). Lester Electronics Scenario. Retrieved April 17, 2009, from University of Phoenix, Simulation, MBA 540. Table 1 Issue and Opportunity Identification |Issue |Opportunity |Reference to Specific |Concept | | | |Course Concept | | | | |(Include citation) | | |Lester Electronics will use equity as capital structure to |Reduce financial |Equity financing is money |Equity Financing | |finance merger with Shang-wa Electronics |obligation, lower |received from the small | | | |financial risk |business owners themselves or | | | | |from other investors. In | | | | |exchange investors are offered | | | | |stock in the company, portion | | | | |of equity | | |Lester Electronics will use debt as capital structure to |Maximizing company |“debt provides tax benefits to |Debt Financing | |finance merger with Shang-wa Electronics |returns |the firm. However, debt puts | | | | |pressure on the firm, because | | | | |interest and principal payments| | | | |are obligations. If these | | | | |obligations are not met, the | | | | |firm may risk some sort of | | | | |financial distress. The | | | | |ultimate distress is | | | | |bankruptcy, where ownership of | | | | |the firm’s assets is legally | | | | |transferred | | | | |from the stockholders to the | | | | |bondholders. These debt | | | | |obligations are fundamentally | | | | |different | | | | |from stock obligations. While | | | | |stockholders like and expect | | | | |dividends, they are not | | | | |legally entitled to dividends | | | | |in the way bondholders are | | | | |legally entitled to interest | | | | |and | | | | |principal payments. (Ross, | | | | |Westerfield, & Jaffe, 2008) | | Table 2 Stakeholder Perspectives |Stakeholder Perspectives | | | | |Stakeholder Groups |The Interests, Rights, and | | |Values of Each Group | |Employees of both companies |Vitality of the organization and product success will cause positions to | | |be created and work to be conducted. | |Company’s executives and Board Members of both companies |It includes the management in regards to making decision that generate | | |profit for the organization as well as safeguarding their position in the | | |new company | |Consumers nationally and internationally |The customer is another stakeholder because they will be investing into a | | |product and getting the most gain or failure once the merger takes place. | |Investors |Investors will evaluate the merger based on potential business growth and | | |future increase in returns on the investment. | Table 3 Analysis of Alternative Solutions [Click twice on table to change, see instructions on next page. The alternatives and their ratings as well as the goals and their weightings shown below are for illustrative purposes, you should enter your own. Delete this paragraph when done.] |Relative Importance (Weight)==> |GOALS |Final Rating | | |Increase |Global |Increase |Customer |  | | | |shareholder |Presence in |revenue and |retention, | | | | |value |products and|sale |satisfaction, | | | | | |services | |and | | | | | | | |base-increase | | | | |2 |3 |4 |5 |  | | |ALTERNATIVE |Primary Alternative Solutions |  | |SOLUTIONS | | | | |A) Develop plan for Financing |1 | | | |Alternative Solution |Risks and Probability |Consequence and Severity |Mitigation Techniques | |Merger with Shang-wa |Loss of local jobs(Medium) |Impact of lost jobs on local |Do not merge all functions at once | | |Loss of employee loyalty(High) |economy |Establish training periods to learn | | |Loss of existing business |Learning curve for outsourced |best practices that may have been in | | | |jobs may take longer |place from local employees | | | |Communication between employees |Establish plan to bring over foreign | | | |and customers may not be |workers to understand company vision | | | |effective or efficient |of being global | |NPV |· It is fairly comprehensive |Disadvantages of relying on NPV | | | |· It is widely used |include: | | | |· It enables easy decisions (NPV > |· It depends on soft data such as| | | |0 = Profitable. NPV < 0 = |market forecasts | | | |Unprofitable) |· There is some complexity | | | | |involved in its calculation | | | | |· It needs enhancements to | | | | |accommodate risk | | |IRR |Advantages of IRR include: |Disadvantages of relying on IRR | | | |· It is easily understood and has |include: | | | |intuitive meaning |· It can be tedious to calculate | | | |· It considers time value of money |(but no more difficult than NPV) | | | |but ignores other risks |· It fails to recognize the | | | | |varying size of investments in | | | | |competing projects | | |PI |Advantages to applying this metric |Disadvantages of applying PI | | | |include: |include: | | | |· It produces a concise number for |· It is not intuitive, and can | | | |project ranking |only be used for ranking projects| | | |· It optimizes utilization of |· It puts weight on available | | | |capital (important if cash is |cash, rather than available | | | |scarce) |resources | | Table 5 Optimal Solution Implementation Plan |Deliverable |Timeline |Who is Responsible | |Present new financial solution to all key |June 2, 2009 |CEO, Owner | |stakeholders | | | |Reassure employees and customers that Lester |June 7, 2009 |CEO | |Electronics will balance stakeholders concerns | | | |related to Merger with Shang-wa | | | |Create team for new merger activities |June 10, 2009 |Senior Mgmt | |CEO reviews plan of communication conduit external |July 1, 2009 |CEO | |with all key stakeholders | | | |Merger company has their management team come in |July 5, 2009 |Senior Mgmt | |for training of best practices | | | |CEO gives 90 day report of testing and measuring |June 5, 2007 |CEO | |progress of going global to stakeholders | | | |Communication team reviews with CEO where |June 15, 2007 |Senior Mgmt | |improvements can be made | | | |CEO reviews outsourcing performance with senior |June 30, 2007 |CEO | |mgmt | | | |30 % of total jobs being outsourced |July 30, 2009 |Senior Mgmt | | CEO gives 90 day report of testing and measuring |Aug 5, 2009 |CEO | |progress of merger to stakeholders | | | Table 6 Evaluation of Results |End-State Goals |Metrics |Target | |With the Merger in place the company should |Review quarterly earnings |12 month target | |focus on increasing sales | | | |Improve existing customers and employees |Review monthly employee performances, sales |12 month target | |satisfaction and loyalty |figures and surveys | | |Global Presence in products and services |Benchmarking competitors every 6 months |12 month target | | | | | | | | |