Star River Electronics Ltd.

...

What is Star River’s weighted-average cost of capital (WACC)? What methods did you use to estimate WACC? What are the key assumptions that especially influence WACC?

Star River’s weighted-average cost of capital is 11.04%. We used the WACC equation Re*E/V+Rd (1-Tax) D/V to estimate the WACC and also the CAPM and the Pure Play Method to figure out some of its components. We also used proxies from comparable firms Wintronics and STOR Max Corp who are operating at the same business level as Star River to figure out Star River’s market values. We found the cost of debt to be 6.6% (6.7% from S.T Debt and 6.46% YTM on L.T Debt) and the weight of debt to be 35%; multiplied those number by 1- the tax rate of 24.5% and found that the weighted-average cost of debt is equal to 1.75% We then found the cost of equity to be 14.27% after finding the average beta of comparable companies, unlevering and then relevering to extract the beta of Star River. We used this beta in the CAPM model and developed a cost of equity of 14.27%. The weight of equity was found to be 65%; therefore we multiplied our cost of equity and our weight of equity to find the weighted-average cost of equity to be 9.29%. When we add our weighted-average cost of debt and our weighted-average cost of equity, we develop a weighted-average cost of capital of about 11.04%

One assumption we made is that the market value of Star River is equal to its book value since most of their debt has a floating interest rate. The second assumption we made is that the market value of Star River’s equity is equal to the average Market/Book ratio that is shared by the comparable companies. The WACC is being influenced by the risk of the company’s line of business and, because of the tax effect of interest, its leverage. The comparable firms market D/E ratios ranges around 30%, while Star River’s market D/E ratio is 53%, the high percentage is cause by its increased reliance on short-term debt borrowing.

What are the free cash flows of the packaging machine investment? Should Koh approve the investment?

The free cash flows of the packaging machine investment are as follows:

2001

$(1,820,000.00)

2002

$47,158.30

2003

$ (7,110.51)

2004

$ (7,987.02)

2005

$ (8,881.72)

2006

$ (9,795.14)

2007

$ (10,727.84)

2008

$ (11,680.36)

2009

$ (12,653.32)

2010

$ (13,647.31)

2011

$ (14,662.99)

2012

$ (60,291.00)

2013

$ (61,352.04)

2014

$ (62,436.83)

2001

$ 0

2002

$ (55,711)

2003

$ (57,223)

2004

$ (2,165,655)

2005

$ (1,853)

2006

$ (2,767)

2007

$ (3,699)

2008

$ (4,652)

2009

$ (5,625)

2010

$ (6,619)

2011

$ (7,634)

2012

$ (8,673)

2013

$ (9,734)

2014

$ (10,818)

If purchased now if purchased in 3 Years

Koh should wait three years before investing. According to the NPV analysis, waiting to purchase the new packaging machine will save Star River about $179,146 in costs.

Conclusion

Adeline Koh is being promoted at a tough time having to tackle Star River’s problems of modernization, leveraging and assets management. There are many decisions that will affect the financial health of the company that need to be made sooner than later. Working with the banker to extend the repayment of the current loan is of utmost importance as well as lowering their leverage ratios to a reasonable number. Moreover, informing the owners of the company that Star River desperately needs either an injection of equity or more long-term debt to successfully turn around operations is also a high priority. In addition, Koh should hold off on investing in the new packaging machine, waiting a few years as seen from the NPV analysis will save her money. Star River should definitely invest in the new DVD packaging machine to continue being a force in competition as they penetrate into the DVD market. Ultimately, the biggest challenge is to be relevant with technology changes.