Mba 540 - Wealth Maximization

Wealth Maximization Concepts Worksheet

Concept Application of Concept in the Scenario Reference to Concept in Reading

Corporate Firm

In the scenario, Lester Electronics, Inc. (LEI) started out in the 1920’s as a small family business owned by Bernard Sr. The business was sold in the 1970’s due to encroaching overseas manufacturers. In 1978, the business was acquired by Bernard Jr. and again become a sole proprietorship. Currently, the company is faced with dilemma of deciding whether to establish a partnership with Shang-Wa Electronics or become a corporation by acquiring Shang-Wa.

“The theory of firms, however, does not tell us much about why most large firms are corporations rather than any of the other legal forms that firms can assume” (Jaffe, Ross, Westerfield, 2005, p. 10).

“The firm is a way of organizing the economic activity of many individuals, and there are many reasons why so much economic activity is carried out by firms and not by individuals” (Jaffe, Ross, Westerfield, 2005, p. 10).

Profitability

Shang-Wa Electronics received an offer from TEC to purchase the company. This company is a key manufacturer for Lester Electronics. If Shang-Wa accepts the proposal from TEC, Lester Electronics will be affected significantly by this takeover. LEI anticipate that the acquisition will cause LEI to lose up to 45% of their expected revenue over the next few years. Due to this situation, LEI is considering the possibility of acquiring Shang-Wa. Analyzing the profitability of Shang-Wa can be useful to TEC in making the appropriate decision.

“A firm is profitable in the economic sense only if its profitability is greater than investors can achieve on their own in the capital markets” (Jaffe, Ross, Westerfield, 2005, p. 38).

“One of the most difficult attributes of a firm to conceptualize and measure is profitability. In a general sense, accounting profits are the difference between revenues and costs” (Jaffe, Ross, Westerfield, 2005, p. 37).

Growth Opportunities

Acquiring Shang-Wa will provide growth opportunities for LEI. The company is currently in a position where they can make a big investment by acquiring Shang-Wa. This tactic will prevent the company from losing up to 45% of its revenue for the next five years. Also, the acquisition will provide LEI with the opportunity to expand its operations to domestic markets.

“A firm’s value increases when it invests in growth opportunities with positive NPVGOs” (Jaffe, Ross, Westerfield, 2005, p. 121).

“Many firms have growth opportunities to invest in profitable projects. Because these projects can represent a significant fraction of a firm’s value, it would be foolish to forgo them to pay out all earnings as dividends” (Jaffe, Ross, Westerfield, 2005, p. 119).

Dividend-Growth Model