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Star Electronic

Essay by   •  April 18, 2017  •  Research Paper  •  2,458 Words (10 Pages)  •  884 Views

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Background:

        Star Electronic was founded as a joint venture between New Era Partners and Starlight Electronics Ltd.. Star River’s core mission was always to manufacture CD ROMs and supply them to major software companies. In the mid-1900’s media products, like CD ROMs, began to grow in popularity. This created an oversupply and decreased the prices by 40%. However, Star River Electronics survived. Contrary to other companies in the industry, Star River’s volume sales had increase at a good rate over the past two years. On the other hand, unit prices were affected by price competition and growing popularity for substitute storage products, like DVDs which had 14 times more storage capacity. Future growth for CD-ROMs was not looking good. According to a study, CD-ROM shipments would decrease from 93% in 1999 to 41% in 2005. The study also predicted that DVDs drive shipments would increase to 59%. Star River decided to experiment with DVD manufacturing to catch up with its growing demand, but it only accounted for 5% of its total sales for 2001. However, it does plan to increase their revenue from DVDs by installing a greater capacity.

Problem:

        The recently appointed CEO of Star River Electronics, Adeline Koh, was faced with several decisions that would affect the company financially. One of its core issues was the repayment of a loan. Koh wanted an extension on the loan from their bank, but her banker did not think Star River would be able to repay the loan in a reasonable period. So, Koh assigned her assistant, Andy Chin, to analyze the company’s historical income statement and balance sheet and forecast the company’s performance for the next two years. She makes serval assumptions like a sales growth of 15% each year, capital expenditures of SGD54.6 million for DVD manufacturing, and any external financing to be in the form of debt. The goal of this forecast was prove to Star River will be able to repay its loans from the bank. If the company proved to be unable to repay its loan, then it would ask for money from its owners, New Era Partners and Starlight Electronics. However, its owners would only give them equity if the company proved to be a good investment or if it was on the verge of failure.

        The second major problem was the plant manager’s, Esmond Lim, request for a new packaging machine. Lim describe their current machine as “terribly inefficient”. Lim explains that the equipment is very slow and requires constant monitoring and repairs. Because it is so slow, they have to pay workers overtime to allow packaging to catch up with production. He believes operations would go by more smoothly with a newer machine. Not only will the new equipment be more reliable but it will also be faster, flexible, and will provide more capacity to meet all production needs. Both Chin and Koh were unsure on whether to buy the new equipment now or later. Although it would save on labor costs, it costs SGD1.82 million. However, Lim points out that manufacturers of packing equipment have been increasing their prices by about 5% per year. So if they buy it now, they can save SGD286,878 rather than in three years. Was Star River Electronics going to be able to repay their loan to the bank? Would it be better for the company to buy new equipment now or in three years?

Recommendation:

        Star River was doing well during the mid- 1990’s, but by 2001 the company was decreasing in value. Star River Electronics had leaned so much on debt in the past and it was starting to affect the company. At this point, Adeline Koh was wondering if they were going to be able to repay their loan from the bank. By forecasting the historical financials using Koh’s requests such as a 15% growth rate, this question could be answered. A two-year forecast showed that Star River would not be able to repay the loan in a reasonable period. The projected short term borrowing still remained positive implying that the loan was not paid off. Since, they were not able to accomplish this task, Star river will have to ask its owners for additional funds. The next issue to address is deciding on buying new equipment now or in three years. Another forecast was used to help in this decision. Maintenance expenses, labor costs, overtime labor costs, depreciations expenses, and total expenses were all projected 13 years to find the different cash flows for buying the machine now and later. When the NPV was calculated using each cash flow, the values showed that it would be better to buy the equipment later. Overall, the company was not experiencing a good period. The company’s financial health will continue to weaken if they continue to borrow money for new equipment. When financing for new equipment Star River should rely more on equity and long term debt rather than focusing on short term debt. This will help improve its liquidity issues. There are also assets like account receivable and inventories that can be reduced to help improve the company’s position. To reduce receivable, give customers an incentive to pay on time. To reduce inventories, the company can change their inventory management system, like JITT.

Question 1: What are the two core issues in this case? In what order should Andy Chin and Adeline Koh address them?

        Adeline Koh was unsure of the company’s future but used the firm’s past performance and forecasted performance to get a better understanding of the company. Andy Chin, Koh’s assistant, was able to calculate diagnostic ratios based on its historical income statement and balance sheet. From these financials, Chin was supposed to obtain a positive or negative insight of the company. Chin also had to figure out its two core issues based on all information gathered. Its first main concern was whether or not they were going to be able to repay the bank loan within a reasonable period.  Mr. Tan, the banker, however did not believe the company was going to be able to do it. He said Star River “was growing beyond its financial capabilities”. In order to answer this, Chin was to project its financial statements for two years. But, if the forecast showed that Star River was not able to repay the loan, they would need to ask for an injection of equity from its owners, New Era Partners. Koh knew that New Era Partners would not invest any additional funds unless Star River proved that its returns on the investments would be attractive or if it proved that the company would be destroyed without their money. The next issue was whether to invest in a new packaging machine now or wait three year to buy it. Esmond Lim, the plant manager, had been having several issues with its current CD packing equipment. Some of the problems it brought was: overtime pay, slower production, several daily repairs, and packing issues. The current cost of the machine is SGD 1.82 million. Koh relied on the forecast to tell her whether now or later is a better time to purchase it. Andy Chin and Adeline Koh would first focus on repaying the loan and then on buying new equipment.

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