The decision to merge with Shang-wa is an important milestone at Lester Electronics Incorporated one that has led to the creation of many goals and expectations for the business. The following proposed solution was designed to assist Lester Electronics Incorporated accomplish its goals while focusing on providing the maximum wealth for Lester’s shareholders through an optimal financial alternative. Situation Analysis In the Bernard Lester scenario Lester Electronics, Inc.
and Shang-wa Electronics were both Corporations started from humble beginnings and both founders of the companies are Chief Executive Officers (CEO) of the businesses. Shang-wa Electronics entered into an exclusive supply agreement with Lester Electronics, Inc. Because of the agreement, Shang-wa is Lester Electronics primary supplier of capacitors for the U. S. market. The two companies entered into a general partnership. “In a general partnership all partners agree to provide some fraction of the work and cash and to share the profits and losses.
A partnership agreement specifies the nature of the arrangement. The partnership agreement may be an oral agreement or a formal document setting forth the understanding,” (Ross, Westerfield & Jaffee, 2005, p. 11). Ford Motor Company and Firestone Tire and Rubber Company, like the two companies in the scenario, also entered into a partnership. The partnership between the two companies lasted until 1996, when several state agencies in Arizona began having major problems with Firestone tires on Ford Explorers.
Ice cream maker, Cold Stone Creamery and fast-food operator Kahala Corporation are an example of two other companies that decided to join forces via a merger to expand their operations. The merger of Cold Stone Creamery and Kahala Corporation will result in a holding company, based in Scottsdale Arizona that will consist of 13 brands. According to The Associated Press, the expected revenues generated will be in excess of $1. 1 billion (The Associated Press, 2007). In addition, the holding company will be comprised of over 3,000 franchises and over 4,000 retail locations in 15 countries (The Associated Press, 2007).
In the scenario, the merger will allow Lester Electronics, Inc. to expand its presence globally, specifically into Asia. Similarly to Cold Stone Creamery and Kohala Corporation, Firestone and Ford Motor Company, Bausch & Lomb, an eye health company, primarily focused on eye care products such as contact lenses, lens care products, and ophthalmic surgical and pharmaceutical products has agreed to merger with a leading private equity investor, Warburg Pincus. The merger includes Warburg Pincus acquiring Bauch & Lomb for approximately $4.
5 billion (The Associated Press, 2007). Because of issues surrounding the company, Baush & Lomb felt that it was definitely in its best interest to merge. Lester Electronics Inc. and Shang-wa are not in the same situation as the two companies mentioned in the preceding, but they can use the merger agreement between the two companies as a template for their own. Issues and Opportunities Merging more than two companies together is often a big risk and involves extensive decision-making.
In making the decision of whether to merge, the companies involved will look at documents such as cash flow statements, bank statements, etc. In the case of Shang-wa and Lester Electronics Incorporated’s merging, both companies have worked together in the past and are aware of the pros and the cons of a merger. In assessing the risks of the merger, financial managers should focus on the issues of long-term debt and measuring economic exposure. Debt represents something that the company must repay; it is the result of borrowing money.
Long-term debt is a promise by the borrowing firm to repay the principal amount by a certain date, called the maturity date (Ross, Westerfield & Jaffee, 2005). When corporations borrow, they promise to make regularly scheduled interest payment and to repay the original amount borrowed. Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action may result liquidation and bankruptcy. One of the costs of issuing debt is the possibility of financial failure (Ross, Westerfield & Jaffee, 2005).
One can again look to Ford Motor Company and Firestone Tire and Rubber Company for as an example of companies with long-term debt issues. During the mid to late 1990s, Ford sold large numbers of vehicles, in a booming American economy with soaring stock market and low fuel prices. With the dawn of the new century, legacy healthcare costs, higher fuel prices, and a faltering economy lead to falling market shares, declining sales, and sliding profit margins. Most of the corporate profits came from financing consumer automobile loans through Ford Motor Credit Company.
By 2005, corporate bond rating agencies had downgraded the bonds of both Ford and GM to junk status, citing high U. S. health care costs for an aging workforce, soaring gasoline prices, eroding market share, and dependence on declining SUV sales for revenues. Profit margins decreased on large vehicles due to increased “incentives” (in the form of rebates or low interest financing) to offset declining demand. Like the two companies in the scenario, Ford Motor Company has to come up with a long-term financing plan in order to keep the company as a profitable status.
In January 2006, the new President of Ford Motor Company announced a plan that includes resizing the company to match current market realities, dropping some unprofitable and inefficient models, consolidating production lines, and shutting fourteen factories and cutting 30,000 jobs. Firestone Tire and Rubber Company were also faced with long-term financing. When the automakers switched to radials in the fall of 1972, Firestone’s bottom-up capital budgeting process functioned flawlessly, quickly converting Ford and General Motors’ demands into concrete commitments to radial production capacity.
In November 1972, marketing managers had already made commitments to supply Ford and General Motors with 433,000 radial tires per month by the following summer and wanted to promise additional tires if capacity was on stream. The President argued that the quickest way to ramp up the additional capacity would be to convert existing factories and in the long term, Firestone would need to build a dedicated radial factory. The Committee instructed the President to proceed immediately to place orders for the long lead-time equipment, thus pre-approving the required capital spending without benefit of formal review or even in-depth discussion.
The Executive Committee reconvened one month later to review the formal request for $90 million to build a new radial factory, ad an additional $56 million to convert existing plants to radial production and build radial inventories. Following the informal authorization granted a month earlier, the Committee treated the request’s approval as a fait accompli, and the discussion focused on implementation details, such as optimal plant location, rather than the fundamental soundness of investing so heavily in radials. Further, in the Bernard Lester scenario, Lester Electronics, Inc.
and Shang-wa Electronics decide to collaborate to establish a new capacitor manufacturing facility in a neighboring Asian country. The venture would enable both companies to meet the growing demand for the product and it would also provide. However, in the case that Lester does pursue the Asian market, it will need to consider how it will measure certain economic exposure. Changes in exchange rates or the value of money, one form of economic exposure, can cause many organizations to pay attention and create strategies to counteract any issues that may arise or to create a plan to enjoy the benefits that may arise as well.
Over the last few years, the value of the United States dollar has been on the decline, it was reported that since 2000, the dollar has decreased by 50 percent in comparison to the Euro (Associated Press, 2007). As a result, companies such as IBM and McDonald’s Corporation have been able to reap the benefits of this drop in the form of increased revenue. Both companies were able to sell its products overseas at a stronger currency and then convert it to U. S. dollars. Both IBM and McDonald’s Corporation are good examples of organizations that are effectively measuring and managing economic exposure that Lester Electronics can mimic.
In both cases, the type of economic exposure encountered is translation exposure. Economic exposure of this kind involves the potential affects that changes in exchange rates can have on an organization’s consolidated financial statements (Eun & Resnick, 2004). Typically, subsidiaries of organizations such as those of IBM and McDonald’s Corporation translate their financial statements from the local currency (Euro in some cases) to the home currency (U. S. dollar). As with any currency related transactions, some risks can occur.
In its decision to expand globally, Lester Electronics Incorporated must take into account the likelihood of random changes in exchange rates (Eun & Resnick, 2004). Essentially, Lester Electronics Incorporated will need to measure the “sensitivities of the future home currency values of the firm’s assets and liabilities and the firm’s operating cash flows to random changes in exchange rates” (Eun & Resnick, p. 284, 2004). In conclusion, similarly to the other companies discussed in the preceding, it is in the best interest of Lester Electronics Inc.
and Shang-wa to consider forming a holding company. The holding company will own either 80% or all of the shares of common stock of the other companies. Lester Electronics for example can be the holding company, while Shang-wa and the off shore Asian facility could be a separate company under the holding company. Forming a holding company, will allow Lester Electronics Incorporated the ability to grow into a conglomerate and eventually enable the organization to acquire other companies, such as those mentioned in the scenario, and blend them into its organizational structure.
Further, by forming a holding company, Lester Electronics will reap the benefits of tax consolidation, including tax-free dividends and the ability to spread operating losses throughout all the companies under its “umbrella”. Concerning financing, it is proposed that Lester Electronics incur additional long-term debt as well as liquidate where feasible any assets that may be of significant value. References Associated Press (2007). Cold Stone Creamery, Kahala to join forces: Merger will join 13 brands; You could build a whole food court, CEO says MSNBC.
com. Retrieved May 15, 2007 from http://www. msnbc. msn. com/id/18602702. Associated Press (2007). Bausch & Lomb agrees to buyout offer: Private equity firm Warburg Pincus to pay $3. 67 billion MSNBC. com. Retrieved May 16, 2007 from http://www. msnbc. msn. com/id/18697545 Eun, C. & Resnick, B. (2004). International Financial Management. New York: The McGraw-Hill Companies. Ross, S. A. , Westerfield, R. W. , & Jaffe, J. (2005). Corporate Finance. New York: The McGraw-Hill Companies. Smith, D. (2007). America’s Most Admired.
Fortune, 155(7), Retrieved Tuesday, April 24, 2007 from the Academic Search Premier database. Stumpf, T. (2001). Ford’s sluggish sales offset by thriving replacement Center activity. Tubber & Plastics News, 31(8), 10. Retrieved Tuesday, April 24, 2007 from the Business Source Complete Database. Taylor III, A. , & Burke, D. (2007). THE FORDS SHOP FOR ADVICE. Fortune, 155(7), Retrieved Tuesday, April 24, 2007 from the Academic Search Premier database. Tires, (2006), Overdrive, Retrieved Tuesday, April 24, 2007 from the MasterFILE Premier database.