Star River Electronics

Star River Electronics

Student’s Name

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Star River Electronics

Introduction

Star River Electronics is a manufacturing company that significant in the production of CD-ROMs. The company is a joint venture, the United Kingdom-based company, the Straight Electronic Limited and an Asian based company New Era Partners. Star River Electronics is based and was very competitive and recognized for the production of CD-ROM and DVDs in the early 1990s.

Issues in Star River Electronics Case

According to this case, technological advancement adversely affects Star River Electronics. First, it leads to a decline in sales volume of the company in the region like North America due to mass production by companies an online data streaming of customers. The unit price for CD-ROM and DVD declined due to the sudden price completion among manufacturers and the increase in the streaming of many customers. Consequently, such issues led to the decline in the company’s gross sale, thus reduces the level of income for Star River Electronics.  Star River Electronics growing beyond its financial capacity, is another vital issue reported in this case. This means that Star River Electronics was unable to repay its bank loan when they fall due.

To respond appropriately to the decline in sales issue,   should adopt advanced technological components to enable the company to have mass production to gain economies of scale. Economies of scale will allow the company to minimize its production cost, thus reducing its product prices (Vanauken et al 2017). As a result, this will attract more customers, thus increases its sales volume in all areas where the company sells its products. As well, setting standard prices for CD-ROM and DVD will make the company’s costs more competitive in the market. Besides, Andy Chin and Adeline Koh should adopt online streaming services to regain its competitiveness in the market.

Additionally, this should include purchasing the new packaging equipment recommend by the plant manager to reduce the production and packaging of the company’s product to minimize production cost. Lastly, to address the issue of the financial crisis, Andy Chin and Adeline Koh should seek financial support from shareholders to increase the company’s capitalization. In doing so, Star River Electronics will have enough financial resources to run all its business activities.

Current Financial Health and Recent Financial Performance of Star River Electronics

The financial health of a company evaluates the ability of the entity to meet all its financial obligations. The general financial responsibilities considered in this evaluation include debt/ loan repayment, deferred stock payments and funding lease of expenses. Currently, Star River Electronics’ financial health is at risk (Byoun, et al. 2015). The company’s debt to equity is 2.02, which is higher than 1. As such, this implies the company finances more of its operation with debt finances compared to shareholders’ equity. Unlike shareholders’ capitalization, debt funding needs to be serviced. As such, this is likely to cause a substantial financial crisis at Star River Electronics.

On the other hand, the company’s current return on equity (ROE) is relatively low that 13.6 %. Usually, the return on investment is used to measure the efficiency of a company to use shareholders’ funds to generate profit and grow the entity (Byoun, et al. 2015). As such, a low ROE as of Star River Electronics for 2015 implies the use of shareholders’ resources but makes fewer profits, thus putting financial health oat risk due to slow growth.

The current financial performance of Star River Electronics is poor since the reported low return on sales (6.3 %) and small return assets (3.7%). Return on sale measures the number of profits generated from the sale of an entity good. The 6.3 % return on sales is meagre, which cannot support all business operations of the company. Besides, return on asset measure to the ability of the company to generate profits using its assets. A low value of return on assets, as in the case of Star River Electronics, shows the poor financial performance of the company since it cannot use its assets to generate huge profits.

Based on the analysis, the company has weaknesses using shareholders’ equity and asset of the company to generate maximum profits. Another weakness of the company that Adeline Koh should be aware of is the excessive use of debt capitalization to fund operations of the company.

Star River Electronics financial statements for 2016 and 2017

Assuming that the company’s sales will increase by 4 % in 2016 and 2017, the new values of sales in 2016 and 2017 will be $ 110,284 and $ 114,695, respectively. Relatively, other factors that are related to sales, such as the cost of goods sold and other factors, will increase correspondingly.  Therefore, the profit of the company will be relatively low as the current and previous years.

2015 sales = $ 106,042

2016 = 104% x $ 106,042

2016 = $ 110,284

2017 = 104% x $ 110,284

2017 = $ 114,695

External Requirement of the Firm for 2016 And 2017

Bank loan 2015 = $ 18,200

Loan amount in 2016 = $ 18,200 x 106.85%

                                   = $ 19,446.7

Loan amount in 2017 = $ 19,446.7 x 106.85%

                                   = $ 20,778.8

Star River Electronics will not be able to repay its loan within reasonable period because its annual profits is relatively low to service bank loan as required. As a result, Andy Chin and Adeline Koh will be forced to seek for financial assistance from shareholders of the company to fund business operations of the company realized the project annual sales volume in 2016 and 2017.

Key Driver Assumptions of Firm’s Future Financial Performance

The key assumption in this case that the company’s sales will increase by 4% in 2016 and 2017. As such, an increase in sales, production costs such as administration and selling expenses, depreciation expenses and income tax expenses will also increase in 2016 and 2017.  As such, this implies that Star River Electronics will sell more of its CD-ROM and DVDs in 2016 and 2017 regardless of market inefficiencies such as unit price competitiveness.

Star River’s weighted-average cost of capital (WACC)

Shareholders’ Equity = $ 49,710

Value of Debt = $ 18,200

Total market value = shareholders’ equity + debt value

= $ 67,910

Beta                         = 1.4

Market risk premium = 6.0%

Treasury = 3.6 %

Coupon rate = 5.75%

The required rate of return = risk-free bond + beta (market return – risk-free bond)

Required rate of return = 5.75% + 1.4(6.0% -1.4)

Required rate of return = 12.00%

Yield to maturity approach was used to calculate WACC for Star River Electronics

Assumptions about what can influence WACC

When calculating WACC the following assumption were mad:

No change significant change in capital structure

No significant change in risks of new projects.

Free Cash Flows of the Packaging-Machine Investment

Koh should approve the investment because its NPV is positive.

References

Botosan, C. A., Plumlee, M. A., & Wen, H. (2011). The relation between expected returns, realized returns, and firm risk characteristics. Contemporary Accounting Research, 28(4), 1085-1122.

Byoun, S., Ng, D., & Wu, K. (2015). Sensitivities of Corporate Investment and Financing Decisions to the Implied Cost of Capital..

Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), 300-315.

Hou, K., Van Dijk, M. A., & Zhang, Y. (2012). The implied cost of capital: A new approach. Journal of Accounting and Economics, 53(3), 504-526.

Li, Y., Ng, D. T., & Swaminathan, B. (2013). Predicting market returns using aggregate implied cost of capital. Journal of Financial Economics, 110(2), 419-436.

Vanauken, H. E., Ascigil, S., & Carraher, S. (2017). Turkish SMEs’ use of financial statements for decision making. The Journal of Entrepreneurial Finance (JEF), 19(1).

Vlaović-Begović, S., Momčilović, M., & Jovin, S. (2013). Advantages and limitations of the discounted cash flow to firm valuation. Škola biznisa, (1), 38-47.