Star Electronic

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Question 2: What is star river's weighted cost of capital

Since is a privately held company, certain assumptions must be made when calculating the WACC. When comparing Star River to other companies in the same industry Wintronics, Inc. proved to be the most similar. For example, Wintronics has a similar growth rate of 15.7% and Star River’s is 15%. Using Wintronics’s beta of 1.56, Singapore’s 10 year T-bond rate of 3.6%, and the current market risk premium of 6%, the cost of equity is 12.96%. Then I divided 2001’s shareholder’s equity by total liabilities and stockholder’s equity to get 25.43% for the weight of equity. The weight of debt was calculated by subtracting the weight of equity from one. The weight of debt is then 74.57%. The cost of debt is found by adding Singaporean prime lending rate, current prime lending rate, and the coupon. When this is done, we get a cost of debt of 12.45%. Lastly, the tax shield is 75.50%.

WACC = (W{debt} * (1-t) * K{debt}) + W{equity * K{equity}

= (74.57%)(75.50%)(12.45%) + (25.43%)(12.96%)

= 10.30%

Question 3: Should Koh approve the packaging machine investment? How do you analyze this issue?

The plant manager had written a memo to the CEO of Star River Electronics explaining the inefficiency of the current packaging machine and his need for a new machine. In order to figure out whether to invest in a new machine now or later, a forecast for 13 years was required. There were many factors that were used in this analysis such as interest rates, labor costs, maintenance expenses, and required rate of return on equity. There were also several assumptions that were made. These include the increasing price of the new machine, different labor costs for both the new and current machine, and the discount rate. The 10.3% WACC helped determine that Star River should purchase the new equipment in 2005 rather than now. The net present value for purchasing it now rather than is 805,236 greater than the net present value for buying it later.

Question 4: How well has star river done in the past? How healthy is it now?

In the 1990’s, Star River performed well due to an increase in popularity for optical and multimedia products. Star River even managed to excel when prices decreased by 40% because of high competition and oversupply. However, unit prices were decrease due to an increased interest in DVD’s. When Star River decided to start manufacturing DVD’s it only accounted for 5% of its sales. But, they did plan to increase their capacity and increase their percentage of revenues from DVD’s. However, its current financial status did not look healthy. The ratio analysis reveals that the sales growth has stayed around 15% over the years which shows consistency. However, in 2000 operating margins dropped 3% which will increase in production costs by 21% and will cause a 20% increase in administrative and selling expenses. There is also a 95% increase in inventory. Both operating expenses and inventory seem to be financed through debt especially since both debt/total liabilities ratios and debt/equity ratios increased in 2000 and 2001. Debt to equity ratios were increasing at a rate of 18.1 % and from 1999 to 2000 there was a 64% increase. Its account receivables also increased each year which was a result in delays in payments by their customers. Star River also showed that it was not using its assets efficiently. ROA had decreased from 5.2% to 3% in 2000. ROE decreased from 1999 to 2000 and then increased in 2001. This may be due to their increasing debt and decreasing equity at that time. Star River Electronics’ need for capital expenditures and excessive borrowing for current operations hurt the company. The balanced sheet shows that short term borrowing had increased every year from 1998 and will continue to increase when it is forecasted. This shows that its cash flows are not able to take care of its overall financial needs. All these factors showed that Star River Electronics’ financial health was weak.

Question 5: Can star river repay the bank loan? How did you contract your financial forecast and what does it show?

The financial forecast shows that Star River cannot repay the loan within a reasonable time period. In order to forecast each statement, I used certain cost drivers such as 15% sales growth rate, and 8% interest expense rate, and a 6.5% cash to sales growth rate. Many of these drives were requested by Adeline Koh. By 2002 short term borrowing is at SGD42 million and SGD14 million in 2003. When you extend the forecast past two years, you will see that short term borrowing and long-term debt increases every year. This forecast shows that Star River current assets do not cover its total liabilities. Much of this is due to debt financing for capital expenditures such as DVD manufacturing equipment. Because Star River continued borrowing and financing their company through debt, Star River was not able to repay the loan in a reasonable period.

Question 6: What are the key drivers of star river's forecast financial need?

One of the major key assumptions is sales. Many of the other assumptions are based on the percentage of sales growth. For example, as sales increase so does the company’s production costs, admin. and selling expenses, inventories, and accounts receivables. For this forecast Koh assumes that there will be a 15% annual growth. However, this is a risk assumption because the market is moving towards DVDs and away from CD ROMS. Star River would need to borrow more money to fully transition into a DVD producing company. Inventory also proves to be another key driver. Inventory make up 60% of the sales and according to the forecast, it will continue to increase. Because inventory is a large portion of sale, Star River’s management should focus on reducing its inventory values.

Question 7: What various priorities should Koh give to all these issues?

The two-year forecast proved that Star River Electronics will not be able to repay their loan at a reasonable time period. This will result in the company asking its owners, New Era Partners and Starlight Electronics, for additional funding towards its company. Star River was to prove that this investment would be worth it for both New Era Partners and Starlight Electronics and if not, it was to prove that the company was in midst of failure. This should be taken care of first because, the amount of debt the company was carrying was hurting the