Star River Electronics Ltd.
Team 14
Constantine Brocoum
Courtney Delia
Stephanie Doherty
David Dubois
Radu Oprea
December 19th, 2009
Star River Electronics Ltd.
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Contents
Objectives ..................................................................................................................................................... 1
Management Summary ................................................................................................................................ 1
Financial Health............................................................................................................................................. 1
Financial Forecast for 2002 and 2003 ........................................................................................................... 3
Key Driver Assumptions ................................................................................................................................ 5
Star River WACC ............................................................................................................................................ 5
Free Cash Flows of the Packaging Machine Investment ............................................................................... 7
Appendices..................................................................................................... Error! Bookmark not defined.
Star River Electronics Ltd.
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Objectives
This report seeks to answer the following five questions about Star River Electronics Ltd.:
1. Assess the current financial health and recent financial performance of the company. What strengths and/or weaknesses would you
highlight to Adeline Koh?
2. Forecast the firm’s financial statements for 2002 and 2003. What will be the external financing requirements of the firm in those years?
Can the firm repay its loan within a reasonable period?
3. What are the key driver assumptions of the firm’s future financial performance? What are the managerial implications of those key
drivers? That is, what aspects of the firm’s activities should Koh focus on especially?
4. 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?
5. What are the free cash flows of the packaging machine investment? Should Koh approve the investment?
Management Summary
Financial Health
The financial health or strength of a company is measured by its ability to service its financial obligations senior to the common
shareholders. These obligations include debt payments, preferred stock payments, the funding of any pension plans and rental and lease
expenses. Below I have highlighted many of the weaknesses of the company.
A common metric investors use to evaluate the ability of a company to service its debt is the interest coverage ratio or times interest
earned. Star River can only cover its interest by a little more than 2 times. This is a worrisome finding. This ratio has steadily decreased
since 1999.
The debt to equity ratios are consistently rising year over year at a compounding at a rate of 18.1%. There was a 64% jump from 1999 to
2000. This is a worrisome trend.
Inventories to COGS ratios are increasing dramatically. Operating margin % has decreased since 1998 both of which are not a good signs.
ROA is a measures how well the firm is using its assets to generate earnings. The ROA has in general decreased by 6.9% since 1998
compounded annually. This indicates that the firm is not using its assets efficiently.
Star River Electronics Ltd.
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The ROE has increased from 2000 to 2001 which may be due in part to the decreasing equity from the increased debt in that time
period.
Debt/total capital ratio is increasing steadily which is secondary to the increasing amounts of debt.
Accounts receivable is increasing as is accounts payable. As time in AR increases the monthly flow of cash slows producing short term
shortages of cash. This may be one reason for the increased short term borrowing. Shortages of cash can also cause problems for Star
River paying their suppliers. This is seen in increasing accounts payable.
A significant weakness of the company lies in the fact that it needs to borrow money for current operations. This when combined with
the need for capital expenditure (new packaging equipment) may be too much for the company to handle. If one evaluates the
Balance sheet you will see that short term borrowing from the bank has increased dramatically since 1998. This indicates that current
cash flows are unable to handle the daily financial needs of the company.
Overall the company’s financial position is precarious. They are taking on too much debt while making large capital expenditures. This in
combination with delays in payments to the company by their customers (increasing AR) and increasing account payable is producing a
precarious financial position. Star River’s financial health is weak and will become weaker if it decides to borrow money to acquire new
equipment.
Star River Electronics Ltd.
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Financial Forecast for 2002 and 2003
Balance Sheets
(Fiscal Year Ended June 30)
(SGD 000)
Assets:
Cash
Accounts receivable
Inventories
Total current assets
1998
1999
2000
2001
Assumptions
5,795 Similar to past few years
35,486 Average of 32% of sales
63,778 Average of 60% of sales
105,059
2002
4,816
22,148
23,301
50,265
5,670
25,364
27,662
58,697
6,090
28,078
53,828
87,996
Gross property, plant & equipment
Accumulated depreciation
Net property, plant & equipment
Total assets
64,611
(4,559)
60,052
110,317
80,153
(42,952)
37,201
95,897
97,899
(89,444)
8,455
96,451
Liabilities and Stockholders' Equity:
Short-term borrowings (bank)1
Accounts payable
Other accrued liabilities
Total current liabilities
29,002
12,315
24,608
65,926
37,160
12,806
26,330
76,296
73,089
11,890
25,081
110,060
84,981
13,370 Average 13% of sales
21,318 Assuming 20,000
119,669
107,394
15,853
20,000
143,247
64,684
18,231
20,000
102,915
Long-term debt2
10,000
Shareholders' equity
34,391
Total liabilities and stockholders' equity 110,317
10,000
36,712
123,008
10,000
38,314
158,374
18,200 Same as last year
40,406 Retention of earnings
178,275
18,200
44,108
205,556
18,200
53,520
174,636
115,153 New DVD equipment over 2 years
(142,889) 1/7 of gross property/equipment
(27,736)
77,323
1
Short-term debt was borrowed from City Bank at an interest rate equal to Singaporean prime lending rates + 1.5 percent.
Current prime lending rates were 5.2 percent. The benchmark 10-year Singapore treasury bond currently yielded 3.6 percent.
2
Two components made up the company's long term debt. One was a SGD10 million loan that had been issued privately
in 1996 to New Era Partners and to Star River Electronics Ltd., U.K. This debt was subordinate to any bank debt outstanding.
The second component was a SGD8.2 million from a 5-year bond issued on a private placement basis last July 1, 2000 at
a price of SGD97 and a coupon of 5.75% paid semi-annually.
Star River Electronics Ltd.
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6,000
39,023
73,169
118,192
2003
6,000
44,877
84,145
135,022
143,153
143,153
(55,789) (103,539)
87,364
39,614
205,556
174,636
Exhibit 1
STAR RIVER ELECTRONICS LTD.
Historical Income Statements
Fiscal Year Ended June 30
(SGD 000)
1998
1999
2000
2001
Assumptions
2002
2003
Sales
Operating expenses:
Production costs and expenses
Admin. and selling expenses
Depreciation
Total operating expenses
71,924
80,115
92,613
106,042
15% /year increase
121,948
140,241
33,703
16,733
8,076
58,512
38,393
17,787
9,028
65,208
46,492
21,301
10,392
78,185
53,445
24,177
11,360
88,983
Average 49% of sales
Average 22.5% of sales
1/7 of gross p and e
59,755
27,438
20,450
107,643
68,718
31,554
20,450
120,722
Operating profit
Interest expense
Earnings before taxes
Income taxes*
Net earnings
13,412
5,464
7,949
2,221
5,728
14,908
6,010
8,897
2,322
6,576
14,429
7,938
6,491
1,601
4,889
17,059
7,818
9,241
2,093
7,148
14,305
6,753
7,552
1,850
5,702
19,519
4,404
15,115
3,703
11,412
2,000
3,728
2,000
4,576
2,000
2,889
2,000
5,148
2,000
3,702
2,000
9,412
Dividends to all common shares
Retentions of earnings
6.7% of short term borrowings
24.5% of EBT
*The expected corporate tax rate was 24.5%.
It is understandable now why Star River was seen as “growing beyond its financial capabilities”. The company needs an infusion of
capital in order to maintain the actual growth rate.
It is unlikely the firm would recover unless inventories are reduced, especially in the context of weakened demand for CD-ROMs and the
associated risk of having to deeply discount or even write them off.
Another item to correct is the Production costs and expenses, currently running at 50% of the revenue. The management has expressed
concerns with outdated packaging equipment and the use of the more expensive second and third shift to catch up with production. An
investment here would probably turn profitable in the context of healthy sale numbers.
Star River Electronics Ltd.
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Key Driver Assumptions
Sales is one of the major key driver assumptions because so many assumptions are based on a percentage of sales. As sales increases, so
do production costs, admin and selling expenses, accounts receivable and inventories. Koh assumes that a 15% year over year growth is
expected. This is a risky assumption since the market is moving away from cd technology to dvd technology. Star River has little capacity
to support future dvd demand without taking on additional manufacturing investments.
Inventories are a staggering 60% of sales and are full of soon to obsolete inventory. It is possible that this inventory of cds will not be
able to be sold at full retail value with the growth of the dvd market. Perhaps more important to the current financial outlook, as
inventories increase, so does the amount the company is required to borrow increases. The company is borrowing money just to
maintain their inventories.
Star River WACC
STOR-Max is the closest competitor to Star River, also being a good match relative to product portfolio, sale percentages and growth
rate. The Equity Beta and Book D/E are provided in Exhibit 3, also Book/Market equity ratio can be determine from book share price
versus market share price as being 0.26. This will help determine the Market D/E ratio at 0.33. Using
Equity Beta = Asset Beta * (1 + D/E)
Star River Electronics Ltd.
we determine STOR-Max Asset Beta to be 1.25.
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WACC Calculation
STOR-MAX Corp used as comparison
Equity Beta Stor-max
Book Debt/Equity
Market share price
Book share price
Book/market ratio
Market Debt/Equity
Asset Beta Stor-max
1.67
1.3
27.48
7.06
0.26
0.33
1.25
Star River
Book Debt/Equity
Market Debt/Equity
Equity Beta StarRiver
Risk free rate (tr)
Expected return on market
Corporate tax rate (tc)
Cost of equity (re)
Cost of debt (rd)
Wdebt
Wequity
WACC
Star River Electronics Ltd.
2.2
0.57
1.96
3.60%
9.60%
22.6%
15.36%
5.75%
0.36
0.64
11.418%
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Another key assumption is made on (Book D/E) / Market D/E) ratio as being the same for the two companies. Being provided with the
Book D/E ratio for Star River, we determine the Market D/E for Star River as being 0.57.
The Cost of Debt would be the interest rate for one of the issued bonds, 5.75%. This is a key assumption, neglecting the other
components of Star River’s debt.
The Risk free rate is similar with the 10-year treasury bond yield at 3.6%, and the market premium would be close to the global equity
market premium of 6%.
With all ingredients provided, the Cost of Equity is calculated through CAPM, rendering it at 15.36%, far lower than the 40% mentioned
as customary when dealing with risky companies.
Further on, WACC would be determined as being 11.418%.
Free Cash Flows of the Packaging Machine Investment
Star River Electronics Ltd.
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