Problem Solution: Lester Electronics

Problem Solution: Lester Electronics

Lester Electronics, Inc. has decided to merge with its long time supplier Shang-Wa Electronics. The companies will need to prepare an implementation plan that focuses on the financial issues. Shareholders will want to know how this merger will impact them in the short term and how the combined company will perform financially in the future. Company leadership will need guidance on the combined capital structure post merger. The CFO will also need to determine if the funds exist or how funds can be raised. LEI will need to determine the capital structure. During this merger, Lester Electronics will need to make it their goal to build wealth by increasing the company’s value. This is accomplished when free cash flow returns are maximized in invested capital with the least amount of risk possible. Remaining financially stable will also be an objective for Lester as current and potential shareholders will need to believe in the stability of the organization.

Situation Analysis

Issue and Opportunity Identification

Poor management is a prime cause of business failure, but so is a lack of capital. If LEI does not have enough capital, the situation may become quite difficult. In addition to having sufficient capital, the CFO will need to plan how that capital is going to be used and managed. The CFO will not want to make critical errors by obtaining the wrong type of financing or errorounously estimating the amount of financing that will be needed. There are several ways to raise financing; self funding from existing cash flows, debt funding borrowed from others, and equity funding rose by selling to others an interest in the business.

The CFO will use financial planning models to determine the best course of action for this merger. Financial planning is comprised of the investment opportunities the firm elects to take advantage of, the amount of debt the firm chooses to employ, and the amount of cash the firm thinks is necessary and appropriate to pay shareholders, (Ross, et al., 2004). These are the financial policies that the CFO must decide on for its acquisition of Shang-Wa. LEI can choose among many alternative capital structures. Taxes and capital market variations further compound the decision making process.

The CFO needs to determine if the company has the financial capacity to complete a merger with Shang-Wa. Lester’s CFO should evaluate its cash flows to see if it has the money to either buy Shang-Wa using the equity that it currently has or to finance. One area the CFO should evaluate is the timing of cash flows. If Lester decides to purchase Shang-Wa using any debt, the financial managers will have to ensure that the timing of the cash flow is such that Lester is able to make the principal and interest payments on the debt (Ross, et al., 2004). For LEI, the challenge will be determining how much money they can outlay. In the event this is not possible, the CFO will need to determine how to raise the additional funds necessary to complete the merger. Deciding upon the capital structure will ultimately determine the potential acquisition’s value.

Financing will become crucial in this merger. Medium-term financing is frequently required for a 3 to 10 year period and is primarily used to finance a business merger itself. Medium-term finance takes the form of term loans, leasing, warrants, and convertibles. Term loans are for an agreed upon period and the principal and interest is paid off in monthly payments. A warrant gives the holder a right to buy shares of common stock for cash, while a convertible bond gives the holder the right to exchange it for shares of common stock, (Ross, et al., 2004).

Long-term financing is used to fund the purchase of assets from a merger. Three primary sources of capital available to LEI are; shareholder's equity, borrowed funds. While the firm can rely on some internal sources, there will not be enough to meet investment needs. The CFO will need to explore external funding sources. These sources include retained earnings, equity capital, preference capital, and long-term loans.

Other long-term financing options include the issuance of common and preferred bonds. Holders of preferred stock have preference in liquidation and dividend payments compared to holders of common stock. However, recent trends in capital structure show that this is a waning alternative. “In the 1980s and recently, U.S. firms retired massive amounts of equity. These share buy-backs have been financed with new debt,” (Ross, et al., 2004, p. 400).

Another challenge will be determining the value of the merger. Discounted cash flows would be one technique as well as multiples of earnings, revenue, or free cash flows. NPV analysis can be used to determine how much