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Lester Electronics Problem Solution

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Problem Solution: Lester Electronics

Problem Solution: Lester Electronics

Lester Electronics Inc. (LEI) has made a decision. The Board of Directors has granted, approval to move forward with the acquisition Shang-wa. Both companies have much at stake; therefore, Bernard Lester is fully aware of the importance of making the best possible financial decisions. LEI must apply financial vehicles to determine the perfect financial mix for success. This paper will propose solutions to LEI’s financial issues regarding the acquisition. The purpose of the paper is to determine the optimal financial solution that maximizes current and future wealth of company.

Situation Analysis

Issue and Opportunity Identification

The potential threat of losing almost 50% of their sales has forced Lester into making a decision that will protect their revenue for years to come. Shang-wa’s acquisition will require strong financial leverage on Lester’s part and that begins with the organization’s understanding of the optimum debt position to be in, for the lowest interest rates possible, when financing is sought after. Shang-wa’s 2004 long-term debt ratio of .69 presents an issue in obtaining lower interest financing and this is not a position Lester is used to being in when considering that they carried a .01 long-term debt ratio in 2004. Lester does have the opportunity to absorb Shang-wa’s poor long-term debt position due to the strength of Lester’s own long-term debt ratio.

An issue Lester must keep at the forefront of the company’s thoughts heading into this acquisition is the potential for expensive financial distress costs due to the Shang-wa acquisition. “Firms can only issue so much debt before encountering the potential costs of financial distress” (Ross, Westerfield & Jaffe, 2005b, p75). Lester is not in a position to be worrying about direct financial distress costs such as bankruptcy, but instead indirect financial distress costs such as lost business due to confidence wavering in customers as they worry about Lester being able to operate as efficiently during post merger days compared to the times before merging when they enjoyed a much healthier financial position. Customers who research the financial health of Lester before the merger and discover that Lester had a debt-equity ratio of .01 in 2004, but when consolidated with Shang-wa the debt-equity ratio skyrockets to .42, could feel uncertain about doing business with a company that is less financially secure than before the merger. Lester has the opportunity to highlight to potential investors the company’s track record of extremely low debt to equity ratios and that this higher ratio is only short-term based on the acquisition needs at hand.

Another important issue facing Lester is the need to use lease alternatives to the maximum extent that presents a financial gain over purchasing. “Firms generally lease for tax purposes. To protect its interests, the IRS allows financial arrangements to be classified as leases only if a number of criteria are met” (Ross, Westerfield & Jaffe, 2005c, p.69). Currently Lester has a much lower dollar amount of leasing costs as compared to Shang-wa meaning that Lester has the opportunity to learn from Shang-wa what leasing options present net present value gains and when leasing leads to losses compared to purchasing. Leasing presents a strong form of medium-term financing and Lester needs to understand these benefits in order to make the smartest financing decisions through this acquisition that will lead to an overall stronger financial debt position.

A fourth issue facing Lester is the percentage of financing that the company should try to obtain to complete the acquisition of Shang-wa. As of year ending 2004 Lester enjoyed a strong cash position of over 34 million dollars leading to retained earnings of over 15 million dollars. In order to maximize wealth for shareholders financing does present some tax advantages over acquiring Shang-wa straight up with cash. The company has the opportunity to discover the strongest long-term financing and cash solution that will ensure wealth maximization for both current and future shareholders.

Stakeholder Perspectives/Ethical Dilemmas

An important stakeholder for the proposed merger is Shang-wa president John Lin. While he prepares for retirement, he has an ethical dilemma to support the needs of his valued and committed employees. His main interest is with helping the company during this transitional time and provides his employees with a bright future. Having spent most of his adult life developing and helping the company grow; John Lin is passionate about a successful partnership with Lester, provided it secures the company’s future.

Bernard Lester, on the other hand is more interested in seizing the opportunity of the business climate. Relying on Shang-wa product sales for years, Bernard Lester has to navigate through this pivotal period of the company’s evolution. He has huge responsibilities and accountabilities towards his shareholders to create a capital structure that fully supports the company’s new direction. He must also weigh the benefits of aggressive financial instruments versus the risk should sales and cash flow falter. The increased financial activities may produce conflict with the day-to-day operations of the company. This will all need to be balanced with meeting sales and cash flow projections.

Meanwhile Lester board of directors will expect sound financial initiatives and displayed efforts to maximize shareholder wealth. Their primary interests will lie with the potential of the joint venture and how the company will be positively impacted by increased sales, controlled operating costs, and improved EBIT and net income. The financing necessary to support the merger will need to be considered with respect to financial markets and the most appropriate financing option, regardless of debt or equity. It will be Bernard Lester, the financial manager, and the board who will need to report the financial state of the company to the public.

Problem Statement

Lester Electronics has recently acquired Shang-wa Electronics in an attempt to stabilize and expand themselves within their industry. With this acquisition Lester will have many opportunities for growth, but with this they need to determine



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