Problem Solution: Lester Electronics

Problem Solution: Lester Electronics

Craig Hugueley

University of Phoenix

MBA 540: Maximizing Shareholder Wealth

Group LM06MBA01

Ronald R. Hallam

March 15, 2007

Problem Solution: Lester Electronics

Lester electronics is merging with Shangwa who currently manufactures an exclusive line of capacitors that represents 43% of Lester's revenue. In the face of Avral offering to acquire Lester and TEC offering to acquire Shangwa, both Lester and Shangwa have decided to merge. This raises several questions for both parties. These questions include but are not restricted to the following: What is the best way to financially structure the merger for all parties concerned? What financial strategies will the post merger organization employ? What new markets will be targeted as a result of these strategies? What changes will be made to the capital structure? What role will financial leverage play in financing of future projects? What solutions will be implemented to execute the new financial strategies? What risks will accompany the different solution selections? What is the approximate timeline that the solution milestones will be completed? These are merely a handful of key questions that surround a merger.

The circumstances that surround the merger underscore the aggressive industry climate that has been foster by giants like Avral and TEC. Lester must chose aggressive growth strategies or watch there market share be consumed by multinationals like TEC and Avral. The solutions must detail an aggressive growth strategy that can sustain long term growth for the post merger Lester electronics. Financial leverage will be increased to sustain growth and lower the current tax burden. With the increased use of leverage the WACC will also increase which will decrease the available project selection by increasing the hurdle rate. However it is projected that there will be more than a sufficient number of projects to drive a minimum of a 25% increase in revenue within two years post merger. Therefore it will be the opportunity cost of capital that will distinguish which projects will be selected. This will be determined by computing the NPV of all competing projects.

Along with financing strategies will be cultural changes and competing stakeholder interests that will require resolution. Each party in the merger has different competitive advantages that the new firm can leverage. One of the key goals is to quickly integrate and feed off of each others strengths. The quicker the two entities can integrate the better the chance of arriving at the best case financials.

Situation Analysis

Issue and Opportunity Identification

The weighted average cost of capital is different for both firms, and up to this point both firms used different financial strategies to optimize capital structure. The different strategies will need to be integrated and overall leverage increased to meet the goals of the new firm. WACC can be used as one of the tools to evaluate the debt equity mix and arrive at the best capital structure of the Lester post-merger.

By the very nature of a merger, there won't be a single financial ratio that won't change. All of the financials of the new entity will be different than either financial of the former entities.

New baselines will be required so that accurate financial projections can be made. Financial Statements and ratio analysis will be among the metrics used to assess the health of the organization as it moves forward.

Without discounting the cash flows that both pre-merger entities would be receiving in the future do to current projects an inflated estimation would be made, causing not only an inflated value of the new entity at the time of merger but also overestimating the future financial projections as well. By discounting the cash flows properly a correct assessment of capital needs and future project valuations will be executed accurately.

The accuracy of any valuation model is questionable. The real question becomes how much is it off and in what direction. Market price is always a better indicator than asset valuation models. Therefore the question in this case is has Lester taken the necessary steps to mitigate the risk of Asset valuation inaccuracies. By evaluating assets with relative accuracy Lester will be able to assess capital demands and forecast more accurately, thus reducing the likelihood of cash flow crisis.

Lester has to decide the appropriate debt load of the firm. Increasing debt financing causes the following to increase: financial leverage, risk, and tax liability. The firm's beta or risk metric is affected by all methods of financing, but is impacted the most by an increase in debt financing. By optimizing financial leverage Lester will finance its projects without over inflating the risk metric or beta. As the beta increases the number of investors decreases.

Stakeholder Perspectives/Ethical Dilemmas

Among the key stakeholders are the Lester Electronics board of directors and management team, the Shangwa board of directors and management team, and the Lester Electronics share holders. Although they share most interests, conflicts will still exist. The primary interest of both board of directors and management teams is to preserving long term growth and maximize the economic value of the organization. The Lester shareholders are concerned with maximizing the value of there shares stock as reflected in the market value of those shares. At this point a merger offer has been tendered and accepted.

So what are the sources of conflict? They are as follows: The specifics of who will be in charge of what, what SOPs will be integrated from both entities and how will they be changed, how the major financial decisions be made going forward and who will make them, and how cultural differences effect decisions, shaping of policy, and establish hierarchy. These are merely examples of the bumpy ride ahead that will occur until the new firm is fully integrated. Well defined policies and procedures will minimize the impact of merging the two firms.

Problem Statement

Lester Electronics will integrate both firms rapidly while adopting an aggressive growth strategy that will allow them to do the following: Increase financial leverage, optimize capital structure, open new markets and increase market share in existing markets.

End-State