Problem Solution: Lester Electronics 1

Running head: PROBLEM SOLUTION: LESTER ELECTRONICS

Problem Solution: Lester Electronics

Albee Horne

University of Phoenix
 Problem Solution: Lester Electronics 2

Problem Solution: Lester Electronics

According to the Scenario University of Phoenix (2009), Lester electronics, owned by

Bernard Lester, was a consumer industrial electronics parts master distributor who contracted

with John Lin, owner of Shang-Wa a capacitor manufacturer. The following analysis will

explore the merger between Shang-Wa and Lester Electronics and other elements which fit into

the equation for solidifying maximization of shareholder’s wealth.

In an attempt to generalize the best solution to aide in the merger between Shang –Wa

and Lester electronics, an attempt will be made to appraise Corporate Performance using

Financial Statements and Ratio Analysis. In addition there will be scrutiny of Corporate

Performance using Discounted Cash Flow Techniques, scrutiny of Corporate Performance using

Asset Valuation Models and a Problem-Solving Approach will be initiated in order to

Demonstrate Critical Thought in Analyzing the given Information.

Critical thought will be given to focusing on identifying key issues, opportunities, end

state goals, bridging the gaps and recognizing the needs of shareholders. It is critical for any

organization to be ethical, in every decision they make towards reaching end goals that will

deliver the greatest financial maximization.

 Problem Solution: Lester Electronics 3

Situation Analysis

Issue and Opportunity Identification

Issues

There were several proposals for combination mergers and acquisitions.

TEC (Transitional Electronics Corporation) wanted to acquire Shang-Wa; which would have

caused a 45% decrease in revenues over the course of five years for Lester Electronics, and

which already had an agreement with Shang-Wa in the terms of distributor vs. manufacturer

(University of Phoenix, 2009).

Another proposal was suggested from Avral to acquire Lester electronics. Shang-Wa's

owner gave Lester the exclusive right to sell capacitors in the US for 65 years; it has only been

35 years though since that agreement. In actuality this would affect shareholder’s wealth due to

the timing of this merge if it had progressed further before the last quarter of sales. (University of

Phoenix, 2009).

Merging or acquire? There are 3 forms of acquisitions merger of consolidation,

acquisition of stock, acquisition of assets, choosing the right business structure will also affect

shareholder’s wealth in different ways.

According to Ross (2004) a merger is defined as absorption of one firm by another, with

the acquiring firm retaining its name, entities, plus additional assets, liabilities of the firm being

acquired. The acquired firm no longer exists after this acquisition (Ross, p797).

A consolidation is the same as a merger except a new firm is created and the same rules

apply as for a merger. If a merger of consolidation is used, then the stockholders must vote to

approve vs. disapprove the merge (Ross, p 797).

 Problem Solution: Lester Electronics 4

Acquisition of stock occurs when voting stocks are purchased in exchange for cash,

shares of stock, or other securities. This can be done privately by the management of another

firm or if done publicly or by one firm to the shareholders of another firm, this is considered a

tender offer (Ross, p 797).

Acquisition of assets occurs when one firm acquires the assets of another firm, but again

the shareholders of the selling firm would have to vote on this type of acquisition (Ross, p 798).

Transcend Services; an Atlanta based company which offers medical transcription

services announced a merge with Medical Dictation Services (MDI), based out of Gaithersburg

Maryland. MDI has revenues in the in the 14.3 million range. The main issue was selecting the

right financial mix for the merger. This brings us back to the question of whether to finance

through debt or capital.

The deal was financed with 10.2 million in cash (this excludes any outstanding debts,

working capital and tax-related adjustments) (“Deals Round Up”, 2009). To break this down

further according to Device Medical Daily quote;

$2 million in cash payable after receipt of interim financial

statements and audited financial statements for the last two fiscal

years, a $2 million note payable to the selling shareholder due one

year after closing, and $2 million of Transcend common stock

(119,940 shares). The initial cash portion of the purchase price is

expected to be funded using a combination of cash on hand and up

to $7 million in bank term debt (“Deals Round up” 2009 p3).

 Problem Solution: Lester Electronics 5

The outcome caused an integration of operations and expanded the company nationally

through the merge. According to Device Medically Daily, revenue is not expected to change

much during the 3rd quarter of year 2009; however, they are expecting an increase in revenue

during the 4th quarter of monitored sales. (Cite)

According to Neely (n.d.), there seems to be a significant correlation regarding stock

returns of the acquirer during the announcement week. The article states that when a merger is

announced that the acquirer experiences slightly negative returns, but two weeks after the

announcements, returns turn slightly positive. When it comes to the acquired company for non

financial acquisitions (banks), they experience abnormal returns with the first week displaying a

very large abnormality followed by 10 weeks of cumulative abnormalities. None of these

abnormalities affect the abnormal returns of targets (“Deals Round up” 2009).

This may be a reality of what Shang-LEI may experience since according to the Scenario

(University Of Phoenix, 2009) Lester Electronics was registered and traded on the NASDAQ

(National Association of Security Dealers Automated Quotations) Market.

Merger-Shang-Wa and Lester Electronics

After referring to Scenario two (University of Phoenix, 2009), it is apparent that both

members of the board of directors, have decided that the ideal method of shareholder’s

wealth/maximization is through the merge with Shang-Wa and Lester Electronics, see appendix

3.

Opportunities

Once the merger is completed, the opportunity exists for the Shang-LEI (Shang and

Lester Electronics) to learn from others who have been through similar instances. For example
 Problem Solution: Lester Electronics 6

finances will be the primary concern, because the company will have to determine the right

capital structure for this new merger project. According to Ross (2004), deciding to finance

through debt or equity defines the company’s capital structure or the value of the firm (Ross, pg

402). The equation representing the value of the firm is V=B+S (Ross, pg.402).

In its Deals Round Up section (2009), Medical Device Daily announces that SonoSite

based out of Bothell, Washington recently proposed a merger with CardioDynamics; which

specializes in impedance Cardiography (ICG) catering to non invasive hemodynamic

assessment.

SonoSite saw the potential to capitalize on the ability to assess both mechanical and

electrical cardiovascular function. In order to capitalize on this merge, it had to be approved by

CardioDynamic’s shareholders. In addition, a capital finance plan had to be incorporated into

this merge

Like Lester and Shang, when SonoSite and CardioDynamics proposed to merge, closing

the deal involved some type of financial expenditure. The decision concerning how this project

will be valued may be described as the weighted-average-cost-of-capital. According to Ross

(2004), this approach begins with the belief that some projects are financed with both debt and

equity. The relationship between this cost of capital is depicted as weighted average of the cost

of debt (WACC) and the cost of equity, represented as;

(Ross 2004, p 401)

Outcome of the response

The merger between CardioDynamics and SonoSite was solidified at a price of about

12.3 million dollars, with 10 million associated with debt and the rest in cash. This acquisition
 Problem Solution: Lester Electronics 7

was approved by the shareholders of CardioDynamics on August 11th 2009. The shareholders for

CardioDynamics will receive $1.35 per share in the form of a cash dividend. (Deals Round Up,

2009)

Even though Shang does not have shareholders to approve the merger, the whole merge

has to be financed either with equity or debt or in a combination of the right mix of both. The

outcome of the merge of Shang-LEI may also lead shareholders (Lester Electronics) to vote on a

new board of directors.

A Leverage buyout (LBO) is comprised of an acquisition of a company, by

another company whether public or private who finances the deal through debt (Ross, p497).

Shang-LEI is faced with this issue and if they decide to take the LBO route, then they will be

expected to generate enough cash flow early on to pay this debt off based on a time table. When

the debt needed to finance future operations is known and can be forecasted, then the Adjusted-

Present-Value (APV) is used in place of the WACC.

The firm can look into short term financing which is considered current liabilities and

relates to net working capital and usually is expected to require a payment within one year

represented by this equation Net working capital = cast + other current assets- Liabilities.

(Ross, pg732)

Whichever decision that is made regarding their capital structure will have to be in the

best interest of the shareholders quote “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, pg 404)”.

 Problem Solution: Lester Electronics 8

Table 1

Issue and Opportunity Identification

Issue Opportunity Reference to Concept

Specific
Course Concept
(Include citation)

A proposal was suggested from Avral A merger is an Merger

In the scenario
to acquire Lester electronics. Shang- acquisition where
LEI/Avril can complete
Wa's owner gave Lester the exclusive the acquired firm
the merger, Lei can also
right to sell capacitors in the US for ceases to exist as
manufacture its own parts
65 years; it has only been 35 years a separate entity.
domestically since
though since that agreement. In The acquiring
merging with Avril null
actuality this would affect firm retains its
and voids any previous
shareholder’s wealth due to the timing name and
agreement contract held
of this merge if it had progressed identity.
with Shang,
further before the last quarter of sales. (Ross, 2004 p.
(University of Phoenix,
(University of Phoenix, 2009). 797)
2009).

Shang-LEI is faced with this issue and When the debt needed to According to Capital
Structure
if they decide to take the LBO route, finance future operations Ross (2004),

then they will be expected to generate is known and can be deciding to

enough cash flow early on to pay this forecasted, then the finance through

debt off based on a time table Adjusted-Present-Value debt or equity

(University of Phoenix, 2009). (APV) is used in place of defines the

 Problem Solution: Lester Electronics 9

the WACC. company’s capital

These are the tools used structure or the

in a leveraged firm. value of the firm

(Ross, 2004) (Ross, pg 402)

When a merger is announced that the In the scenario Any company Stock and
bonds
acquirer experiences slightly negative In 1984, Bernard took his should buy assets

returns, but two weeks after the company public, and it is that generate

announcements, returns turn slightly now traded on the more cash then

positive. When it comes to the NASDAQ market and they cost and they

acquired company for non financial rated Baa by a Nationally should sell bonds

acquisitions (banks), they experience recognized rating agency and stocks that

abnormal returns with the first week (University of Phoenix, raise more money

displaying a very large abnormality 2009). than they cost.

followed by 10 weeks of cumulative Surely Bernard has Cash is paid out

abnormalities (“Deals Round up” shareholders whose to investors in the

2009). wealth is maximized by form of interest

the payout of dividends. and dividends

If The Baa rating for (Ross, 2004 p. 6)

Bernard is substantially

high, this will attract

more investors like

shareholders, the more

cash generated then the

higher the dividends, this

 Problem Solution: Lester Electronics 10

increases shareholder’s

wealth.

(Ross, 2004 )

In the scenario Any company Long-

Long term financing according to term
should buy assets financing
Ross (2004), is a category that may In 1984, Bernard took his
that generate
include interest, principal payments, company public, and it is
more cash then
and dividend payments to now traded on the
they cost and they
shareholders (Ross, pg 743). NASDAQ market and
should sell bonds
rated Baa by a Nationally
and stocks that
recognized rating agency.
raise more money

Surely Bernard has than they cost.

shareholders whose Cash is paid out

wealth is maximized by to investors in the

the payout of dividends. form of interest

If The Baa rating for and dividends

Bernard is substantially (Ross, 2004 p. 6)

high, this will attract

more investors like

shareholders, the more

cash generated then the

higher the dividends, this

 Problem Solution: Lester Electronics 11

increases shareholder’s

wealth (University of

Phoenix, 2009).

Net Present value of stock In the scenario The NPR is a Net

(NPR) Present
Bernard Lester’s good indicator of value of
stock
company is traded a good vs. bad (NPR)

publicly investment. NPV

So if a merge were to uses cash flows

occur between his and from a project

another company the which in turn is

company’s cash flow will used to determine

be affected which in turn dividend

will affect the present payments, other

value of his company’s corporate

stock. projects, or

When deciding to merge payments of

or acquire each company corporate interest.

presented has to analyze (Ross, 2004 p.

the NPV in order to 146) “That is,

determine if the proposed NPV is the

investment is a good present value of

investment or perhaps on future cash flows

 Problem Solution: Lester Electronics 12

that should not be entered minus the present

into. value of the cost

of the investment.

“ (Ross, 2004 p.

62)

Stakeholder Perspectives/Ethical Dilemmas

The stakeholders obviously have the most to lose. To begin you have the Shareholders

who have part ownership within the company due to stocks. The shareholders must be told about

the proposal for an acquisition, for it would be UN ethical to not inform the owners (partial) of

the corporation. This may cause a drop in stocks if the shareholders view this as negative but that

is a risk that must be taken by the company.

Bernard is the owner of LEI (Lester Electronics Inc) all of his financial livelihood is tied

up in the company and is his investment. It is in his best interest to see to it that this project is

successful.

John Lin is the owner of Shang-Wa and likewise his interests are mutual in comparison to

Bernard. It would be most beneficial to pursue the merge and ensure its success.

Table 2

Stakeholder Perspectives

Stakeholder Perspectives

Stakeholder Groups The Interests, Rights, and

Values of Each Group

 Problem Solution: Lester Electronics 13

Shareholders These individuals own shares in the

company and could stand to lose out financially if

the merger is un successful.

Bernard Lester (LEI) He invested all of his assets and liabilities

he is tied and hopeful of the success of this

decision since he has all right to profit share etc.

John Lin (Shang- Wa) He invested all of his assets and liabilities

he is tied and hopeful of the success of this

decision since he has all rights to profit share etc.

Problem Statement

Shang-LEI aspires to increase shareholder’s wealth, but has not defined the

adequate corporate structure, in order to analyze risks associated with their investment in

order to reach its end state goals. There are multiple opportunities for Shang-LEI to

increase wealth and define company structure, and mitigate risks. There are tools that can

easily help with this problem if used correctly. These tools that are directly related to the

financial aspects of the company’s progress in relation to finding a solution to the

problem and reaching their end state goals could potentially include the following;

1. Appraisal of corporate performance using financial statements and ratio

analysis

2. Assessments of corporate performance using discounted cash flow

techniques
 Problem Solution: Lester Electronics 14

3. Analysis of corporate performance using asset valuation models

End-State Vision

The end state is to increase the profitability of the company and at the same time,

maximize shareholder's wealth. In order to do this, the company needs to decide which areas to

invest in, how to increase cash flows, and how to manage present and future financial affairs.

Table 3

End State Goals

Shang-LEI optimized the greatest solution for increasing shareholder’s wealth by

merging into one. The potential is there for an increase in manufacturing (expansion of facilities)

and distribution (69% increases with consolidation) capacity (appendix 1). This is due in part

because of previous distribution regions that if combined will fuel the demand for higher

production ultimately increasing sales.

The projected sales after the merge were up by over a million (appendix 2). This will

easily become reality once each of the previous mentioned potentials are met.

End-State Goals
Shang-LEI have merged as one company and maximized shareholder’s wealth
Shang-LEI have consolidated assets and capitalized on a core increase of 69% in distribution
Shang-LEI through combined assets have increased their manufacturing capacity
Through increased manufacturing capacity, sales have also increased

Alternative Solutions
 Problem Solution: Lester Electronics 15

According to Burge (1994, November) many mergers may use multi sources of financing

options. In the most part some of these financing firms require 25%-50% of the purchase price in

equity and returns in the 30% range. (Burge, par 1).

Mr. Burge goes on to describe the differences between a leverage acquisition and a

traditional raised buyout.

In a leveraged acquisition, company A, an operating business, acquires company

B, also an operating business. Lenders can, on a pro forma basis, take the cash

flow of both companies, combine it, and leverage against it. So, the now merged

company can borrow its senior debt and subordinated debt on a combined basis

and use the combined cash flow, including the synergies that are theoretically

achieved by combining the two companies, to pay back the debt. As a result, the

whole becomes worth more than the sum of its parts, creating a high return on

equity. Often when one company acquires another, there is no need to raise

additional equity. There already is equity in the acquiring company and it can rely

on the subordinated debt or senior debt markets to obtain the capital to acquire the

other business (Burge, pars 3, 4).

Historically when it comes to being bought out by a leveraged firm 10% of the purchase

price would be invested as equity, the rest of the debt would be purchased with debt. We use the

example given by Burge (1994, November) which involves a purchase price of 25million dollars

for the purchase of firm B to firm A. In this example 2.5million will be invested as equity and

the rest in debt. It is assumed that in 5years 10million of that debt would be repaid, and if the

company was resold for about 25 million then the 2.5million of the original equity would now be

worth 12.5million or 5 times the original investment price. This would be a 40% rate of return on
 Problem Solution: Lester Electronics 16

the project over that 5 year period, and while all the company did was repay the debt, each dollar

spent towards the debt was also a dollar of value earned Burge (1994, November).

Now things are different and with leverage financers requiring 25%-40% of the purchase

price in equity, repaying the debt is not simply enough, and what may have required 2.5million

as the down payment in equity may now require 8million in equity and even if the debt is retired

and the company is sold, the rate of return is much lower, say 25% as opposed to historical

returns Burge (1994, November).

Burge speaks of a real closing to help generalize this concept quote

In a $50 million deal that closed recently, the equity sponsor group financed it with 100%

equity. All $50 million came right out of its fund and a $150 million acquisition line was

put in place. The fund is going to create its leverage in the future by acquiring other

businesses with debt (Burge, pars 9).

Also according to Burge (1994, November) senior debt is the lowest risk and has the

lowest return rate and senior secured debt used mostly in situations where cash flows are

uncertain. He also adds that returns and values are more likely to come from improving

operations then from straight debt repayment.

What this means for Shang-LEI is that not only do they need to look at the present

purchase price and come up with 25%-40% equity but they will also have to determine the rate

of return on this debt (discount rate) in order to figure out if the company is making the correct

decision.
 Problem Solution: Lester Electronics 17

Another issue is cash flows, and the new merger will have to calculate the projected cash

flows to see if they will maintain their debt from daily operations, calculate returns and values to

see if they are enough to cover their long-term debt which can free up additional funding for

future investments.

Determining proper investments of levered vs. unlevered firms differs by the method

used to determine if a project should be accepted. Adjusted Present Value (APV) is more

favorable to a levered firm where Net Present Value (NPV) is used more often in a majority

equity firm. According to Ross (2004), the cost of capital decreases with leverage in which a

normally negative NPV for a project (calculated by an equity firm) may be considered a positive

move for a levered firm.

According to Ross (2004) “In words, the value of a project to a levered firm (APV) is

equal to the value of the project to an unlevered firm (NPV) plus the net present value of the

financing side effects (NPVF)”.

(Ross, 2004, p 477).

The four things affected by this equation are Tax subsidy to debt, cost of issuing new

securities, the cost of financial distress, subsidies to debt financing. (Ross, 2004)

We find these familiar terms mentioned in the merger between Transcend Services and

MDI “ etal.. $2 million note payable to the selling shareholder due one year after closing, and $2

million of Transcend common stock (119,940 shares)

Analysis of Alternative Solutions

 Problem Solution: Lester Electronics 18

Analysis of Alternative Solutions

Based on the research by Burge (1994, November), a 40/60 equity to debt financing

option was assumed and Rated a 5(high) for aligning with the goal of creating the right financial

mix and according to Burge, the equity financing should be 25%-40%.

Financing with a 40/60 mix had little to do with the 69% in distribution assets, but the

merge itself is what played the biggest part in relation to this goal. Since the type of financing

itself had little correlation with the distribution increase, this was rated a 1(low).

The 40/60 financing mix did not contribute totally to the increase in sales but had an

impact on sales, since without the financing the merger would not exist, and there would not be

any potential to raise revenue etc. This was rated a 3(middle), even though the association was

weaker, but stronger then the correlation between the financing and the distribution percentage

increase. The overall ratings for the before mentioned in relation to meeting the goals that were

specified was given a 3.15.

The Next alternative which is the consolidation of distribution assets in correlation with

the goals of financing with the right mix of equity received a one. It is significant that the merger

occurred which would allow the alternative, but the actual financial mix bares little relevance.

When it came to the 69% increase in distribution assets and sales in relation to the

alternative of consolidating distribution of assets, they rated a 5(high) for each in which created

the accumulative avg. of 3.46

The last alternative of increasing production through combined assets in relation to the

financial mix received a 5(high) because the correlation between the two goes hand in hand.

When referring to the 40/60 representation, the 40 corresponds to the assets used in financing.
 Problem Solution: Lester Electronics 19

This rate was giving to the increase in distribution and increase in sales creating a 5.0 overall

rating.

Even though financing the correct mix is important sales and asset distribution seem to be

the driving force, pertaining to the overall goal, which is the maximization of shareholder’s

wealth.

Table 3

Analysis of Alternative Solutions

Problem Solution: Lester Electronics 20
 Problem Solution: Lester Electronics 21

Alternative Solution Evaluation Matrix

GOALS

Financemerger with rightequity

69%in distribution Goal B

increasesales
mix
Final
Relative Importance (Weight)==> 5 4 4 Rating
ALTERNATIVE SOLUTIONS

Primary Alternative Solutions

A) Financeusing40/60equitydebt
ratio 5 1 3 3.15
B)Consolidatedistributionassets 1 5 5 3.46
C)increaseproductionthrough
combinedassets 5 5 5 5.00
D) -
E) -
Secondary Alternative Solutions
-
-
-

5 = High
4 = Middle to High
SCALE==> 3 = Middle
2 = Low to Middle
1 = Low

Note: This table format varies from APA standards in conformity with guidance contained in the preface to
the APA Publication Mannual, 5th edition.
 Problem Solution: Lester Electronics 22

Risk Assessment and Mitigation Techniques

According to Haim (1978) the economic cost of bankruptcy should be factored in to any

decision regarding capital structure. The article goes on to state that the value of a firm increases

with leverage. In order to demonstrate an example was given of a firm whose value increased up

to 10, 000 in debt alternative, but declined at 15,000. This proved that at 10,000 the debt equity

ratio was 50% and was considered the optimum financing for the firm. The article further states

that incorporating the bankruptcy risk into the valuation model that the probability of financial

failure increases as the financial ratio increases (Haim, pg1).

Shang-LEI can use to benefit from a lower debt equity ratio if it is to help them from

defaulting in the future, based on the burden of debt that the newly merged company is carrying.

According to Shrivastava (1986), the merger who aspire to maintain growth and

diversification are not always successful quote;

In 1984 alone, over 2,500 mergers

worth $122 billion collectively were accomplished.

Even though the number of mergers has

been increasing considerably, mergers aimed at

attaining growth and diversification are not always

successful. For instance, activities of Lytton

Industries before the 1980s provide a spectacular

example of a company that used a merger

strategy for this purpose. From 1953 to 1967,

 Problem Solution: Lester Electronics 23

Lytton Industries grew from a $200 million company

to a $1.6 billion conglomerate. But in the

next decade, the size of the company declined

severely (Shrivastava, par 1).

The author goes on to state a correlation to un related diversification and conglomeration

to related diversification as being a difference in financial performance, capital productivity,

higher market risks, and higher degrees in variance in relation to performance (Shrivastava

1986).

All of this can be contributed poor choice in merger partners, in appropriate pre merger

analysis, poor design of a diversification strategy, and lack of integration between merged firms.

Examples of which are quoted;

This lack of integration

has led many recent mergers to disastrous performance.

Coca-Cola acquired Wine Spectrum,

hoping to bring its marketing prowess to a sleepy

wine industry. A few years later and after several

million dollars in losses, Coca-Cola divested Wine

Spectrum. In 1981, Fluor Corporation played

white knight to St. Joe Minerals Corp. and saved

it from Seagram Company's takeover attack in a

deal that cost $2.2 billion. In the past four years, a

clash of corporate cultures, an exodus of key

personnel, and an overall failure to integrate has

 Problem Solution: Lester Electronics 24

caused St. Joe to lose millions of dollars. However,

few analysts have examined the problems of

integrating firms after the merger has been consummated

and the impact of this lack of integration

on performance (Shrivastava, par 3).

What it all boils down to is that a merger has to integrate the newly merged firm into a

single unit. According to the author this must occur at several levels such as; accounting systems,

physical assets, product line, production systems, technology, and cultural levels (Shrivastava,

1978).

This leads to the last two alternatives for Shang-LEI, who can also take the opportunity to

integrate its assets in order to reach its end goals.

Table 4

Risk Assessment and Mitigation Techniques

Risk Assessment and Mitigation Techniques

Alternative Risks and Consequence Mitigation Techniques

Solution Probability and Severity

Finance • If the • A • Return Variance can be expected, the term

using 40/60 return rate negative standard deviation can be calculated using

equity debt is negative return the square root of the variance formula

ratio or lesser could

than the cause (Ross, pg 257)

asset, the risky cash You can use the results of the returns in
project can flows comparison from the expected returns to
be in (Ross, make a managerial decision to get the
 Problem Solution: Lester Electronics 25

jeopardy 2004) project back on track.

(Ross, pg. • Default on

321) (High debt (Ross

risk) pg 434)

• A possible • A higher

risk is that discount

if during rate could

debt be riskier

managing then the

and investmen

monitoring t decision

one (Ross, pg

realizes the 213)

discount

rate should

be higher

(High)

• A project

should be

taken only

if the

return rate

is greater
 Problem Solution: Lester Electronics 26

than the

financial

asset of the

risk (Ross,

2004)

• The

probability

of the

merger

taking on a

project

with a

negative

return is

low

Consolidate • If the • This will • In my opinion research is the key to

distribution distribution affect the possibly predicting future trends.

assets markets bottom

become line, in my

smaller due to opinion.

economy or

things out of

the mergers
 Problem Solution: Lester Electronics 27

control,

• The

chances of

predicting this

is slim, but the

chance of this

occurring at

the moment of

the merge is

also minimal.

Increase • More • This could • If the debt ratio is high then expand later,

production assets may be cause for a make what money you can now.

through needed as need in

combined opposed to just more

assets consolidating capital

• This is

highly

probable if the

company

chooses to

expand

globally right
 Problem Solution: Lester Electronics 28

after the

merge.
 Problem Solution: Lester Electronics 29

Optimal Solution

In putting it all together it would appear that the optimal solution is to merge as a levered

firm. I have researched how several companies’s dealt with the merger decision and their choice

of capital structure. Based on the research by Burge (1994, November), a 40/60 equity to debt

financing option was assumed and Rated a 5(high) for aligning with the goal of creating the right

financial mix and according to Burge, the equity financing should be 25%-40%.

After financing the merge, the next thing is to consolidate or integrate. According to Shrivastava,

(1978), quote

The primary problem in effectively managing

merged firms is integrating them into a single unit.

This integration must occur at several levels. The

initial and perhaps easiest integration of the

merged firms is done through the integration of

procedures that is achieved by combining the

accounting systems of the two firms and creating

a single legal entity. Another type of integration is

the integration of physical assets, product lines,

production systems, and technologies. The most

critical type of integration is cultural integration

(Shrivastava, par 4).

It would appear that the consolidation of these assets would improve performance and in the long

run improve profitability of the firm. These sets of solutions combine as one in order to

incorporate the most maximization, of shareholder’s wealth.

 Problem Solution: Lester Electronics 30

Implementation Plan

Table 5

Optimal Solution Implementation Plan

Deliverable Timeline Who is Responsible

Secure financing from a capital April 08, 2005, merger close Lead CFO (Anne Lorale)

investment bank date April 15th

Begin the initiative to start April 16st initial meeting held, Directors

implementation of all systems. weekly meeting will follow Finance

Each department head will co per company protocol, the Information technology

lead the project, for their actual report for this initiative Logistics

specialized departments, creating is due in 14 days April 30th. Production

detailed documentation of the HR

working of every aspect of their Research

department, which will be turned

in later, to the directors who will

meet with top executives.

Distribution combined, assets and Report due May 8th, 2005 Production (managers)

production warehouse combined

and some assets that are no

longer needed and could be sold

off, must be provided within a

report
Additional research on expansion Report due May 8th, 2005 Finance(managers)

after the merger will be required Research(managers)

to check progress on expansion Logistics(managers)

 Problem Solution: Lester Electronics 31

plans along with financials, and

necessary resources proposals

After review of expansion policy May 16th, 2005 Management of these

the decision is made to postpone departments will work

the expansion but integration of with their corresponding

assets begin for departments directors

IT

Finance

Production

(1st phase)
Liquidation of un needed assets May 26th, 2005 Management of these

begin and integration of the departments will work

remaining departments with their corresponding

Logistics directors

Hr

Research

(2nd phase)
Integration, and asset June 6th completion CEO and VP

consolidation/liquidation (responsible for ensuring

complete completion)

Evaluation of Results
 Problem Solution: Lester Electronics 32

The end state is to increase the profitability of the company and at the same time,

maximize shareholder's wealth. The company has done this by deciding which areas to invest in,

how to increase cash flows, and how to manage present and future financial affairs.

Shang-LEI has recognized the importance of figuring the right rate of return, and

monitoring deviations of such in order to stagnate negative cash flows. Asset valuation models

were also utilize such as APV, NPF or WACC.

End State Goals

Shang-LEI optimized the greatest solution for increasing shareholder’s wealth by

merging into one. The potential was maximized by increasing manufacturing, (expansion of

facilities), distribution (69% increases with consolidation) and capacity (appendix 1). This is due

in part because of previous distribution regions that if combined will fuel the demand for higher

production ultimately increasing sales.

The projected sales after the merge were up by over a million (appendix 2). This will

easily become reality once each of the previous mentioned potentials are met.

Table 6

Evaluation of Results

End-State Goals

Shang-LEI have merged as one company and maximized shareholder’s wealth

Shang-LEI have consolidated assets and capitalized on a core increase of 69% in distribution

Shang-LEI through combined assets have increased their manufacturing capacity

Through increased volume sales has also increased

 Problem Solution: Lester Electronics 33

Conclusion

In order for Shang-LEI to meet their goals, a series of plans were introduced to finance

using the right mix, along with consolidation and integration of current assets, and liquidation for

un needed ones. By consolidating and integrating the existing manufacturing processes,

production rates increase.

Shang-LEI will have to integrate its whole culture keeping its mission statement the

same. They will have to be more analytical towards spending and future investments allowing

the chance for their cash flow to increase; this is specifically regarding risk management and

performance monitoring. This could mean specialized persons to handle financial planning, risk

management and monitoring of the performance of the company in order to forecast deviations

or suggest contingencies for unfavorable variances in performance. These groups were included

in the implementation plan and included, key personnel for departments like finance, IT, Hr,

research, etc.

Decision making relating to major projects such as mergers and acquisitions do not seem

to be an easy task to decide. You must keep shareholder’s interest in mind before making a

decision. It is UN ethical to not inform shareholders of propositions for merges etc. They are

owners and have a stake in the business which means they have much to lose.

Financial planning is beneficial for future projections and daily monitoring of risk factors posing

financial hazards. Tools such as accounting balance sheets and cash flow sheets present the data

needed to calculate proper ratios for monitoring of the company’s performance and risk factors.

With the above checks and balances in place, end goals are easily met and obtained

throughout the life of the business.

 Problem Solution: Lester Electronics 34

References

Burge, Steven W. (1994, November). Mix and match plans to finance leveraged build-

ups. Mergers and Acquisitions, 29(3), 31. Retrieved September 12, 2009, from

ABI/INFORM Global

Deals Round Up (2009, August 18). Medical Device Daily. Retrieved September 6, 2009

from ProQuest database.

Haim, L.(1978). Bankruptcy risk and the choice of financial structure. Management

Research News. 1(3), 8-9

Ross, S.Westerfield, R., & Jaffee, J. (2004). Corporate Finance (7th ed., p. 803). New

York: McGraw-Hill.

Shrivastava, P.(1986). Post Merger Intergration. Journal of business strategy.7(1), 65-76

University Of Phoenix (2009) Scenario One: Lester Electronics. Retrieved September 6th,

2009, from University of Phoenix website.

Appendix 1

Distribution tables

Appendix 2

Consolidated Income statements for Lester and Shang

Appendix 3

Scenario Two

Appendix 4

Statement of Cashflows
 Problem Solution: Lester Electronics 35

Appendix 1

TEC

Transnational Electronics Corp. Geographical Distribution Table

Europe 27%
Asia 1%
Middle East 2%
Africa 1%
South America 18%
Canada 7%
Central America 9%
United States 35%
Total 100%

Shang-Wa

Shang-wa Geographical Distribution Table

Europe 21%
Asia 11%
Middle East 9%
Africa 3%
South America 13%
Canada 8%
Central America 4%
 Problem Solution: Lester Electronics 36

United States 31%

Total 100%

Lester

Lester product distribution by manufacturer

Shang-wa Electronics Company 43%

Taiwan Components Company 19%
Indian Electro Parts Company 8%
Caribbean Electronics Company 17%
USA Components, Inc. 13%
Total 100%
 Problem Solution: Lester Electronics 37

Appendix 2

Income Statements Projections

12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006

539,520.4 604,262.9 676,774.5 757,987.4 848,945.9

Sales 9 4 0 4 3
420,945.2 475,668.1 537,504.9 607,380.6 686,340.1
Cost of sales 5 3 9 4 2
118,575.2 128,594.8 139,269.5 150,606.8 162,605.8
Gross profit 4 1 1 0 1

Operating expenses:
31,570.3 33,148.8 34,806.3 36,546.6 38,373.9
Selling, general and administrative 5 7 1 3 6
4,500.0 4,635.0 4,774.0 4,917.2 5,064.7
Research and development 0 0 5 7 9
15,971.0 17,004.9 18,105.7 19,277.8 20,525.8
Depreciation expense 4 4 7 6 4
Amortization - goodwill - - - - -
Amortization - other intangibles - - - - -
Other operating expense - - - - -
52,041.3 54,788.8 57,686.1 60,741.7 63,964.5
Total operating expenses 9 1 3 6 8
66,533.8 73,806.0 81,583.3 89,865.0 98,641.2
Operating income 5 1 8 4 3
 Problem Solution: Lester Electronics 38

Appendix 3

March 29, 2005

Email
To: Executive Leadership Team
From: Board of Directors
CC: Board of Directors

We believe that combining our efforts with Shang-wa will bring success to the firm and therefore
propose a merger with them. Please move forward with creating a financing recommendation
with an analysis detailing all of the possible alternative financing options available to us.
 Problem Solution: Lester Electronics 39

Appendix 4

Statements of Cash Flow Consolidated

12/31/2002 12/31/2003 12/31/2004

Cash Flows from Operations

8,417.2 21,582.6 40,931.8
Net Income 5 5 0
13,901.0 14,088.0 15,000.0
Add: Depreciation 0 0 0
(4,767.0 (2,648.3 (10,771.9
Change in A/R 0) 8) 3)
(6,507.0 (10,457.0 (11,220.0
Change in Inventory 0) 0) 0)
(2,389.0
Changes in Other Current Assets 0) 616.00 538.00
(6,289.0 21,417.8 4,790.4
Changes in A/P 0) 8 3
Changes in Other Current 4,705.0 15,358.0 (5,245.0
Liabilities 0 0 0)
Cash flows from Operating 7,071.2 59,957.1 34,023.3
Activities 5 5 0

Cash Flows from Investing

Purchase of Property, Plant & (19,537.3 (39,654.6 (46,639.8
Equip 0) 0) 0)
5,755.0 1,236.0 8,356.0
Sale of Property, Plant & Equip 0 0 0
(202.00 (17,010.0 (4,600.0
Purchase of Market Investments ) 0) 0)
Sale of Market Investments 500.00 552.00 765.00
(404.00 (460.00 (4,310.0
Leasehold Improvements ) ) 0)
Cash flows from Investing (13,888.3 (55,336.6 (46,428.8
Activities 0) 0) 0)

Cash Flows from Financing

9,155.0 10,223.9 15,694.0
Borrowing 5 5 0
(1,618.0 (1,618.0 (1,618.0
Repayment of Principal 0) 0) 0)
Sales of Stock - - -
(5,027.0 (10,259.5 (20,938.0
Dividends 0) 0) 0)
Cash flows from Financing 2,510.0 (1,653.5 (6,862.0
Activities 5 5) 0)

(4,307.0 2,967.0 (19,267.5

Net Cash Flows 0) 0 0)
Beginning Balance Cash & 59,436.0 55,129.0 58,096.0
Equivalents 0 0 0
Ending Balance Cash & 55,129.0 58,096.0 38,828.5
Equivalents 0 0 0
Problem Solution: Lester Electronics 40