Mba-540 Wealth Maximization Concepts Worksheet
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Wealth Maximization Concepts Worksheet
Concept
Application of Concept in the Scenario
Reference to Concept in Reading
Identify relevant cash flows including initial investment that are incremental to the firm.
Lester Electronics, Inc. has finally reached its decision: to merge with its long time supplier Shang-Wa Electronics. Through recent mergers and acquisitions, the company has developed enough resources to expand globally. Many reasons have been offered by financial managers to account for frequent merger activity. Merger provides an opportunity to bring together and increased the value of the combined enterprise. Mergers serve to increase market share, gain competitive advantage and improve shareholder value. Corporate growth usually occurs internally when a firm expands its existing departments through normal capital budgeting activities. All stakeholders have the right to expect benefits from this merger (Lester Electronics Scenario, UOP).
“Capital budgeting must be placed on an incremental basis that sunk costs must be ignored, while both opportunity costs and side effects must be considered.” (Ross, 2004, Ch 7).
Use Net Present Value (NPV) method, Internal Rate of Return (IRR) method for capital budgeting decisions.
Anne Lorale, CFO, Lester Electronics must use financial planning models to determine the best course of action for this merger. CFO must decide on financial policies:, Net Present Value, the payback rule, the accounting-rate-of-return rule, the internal rate of return (IRR), and the new entity’s profitability for its acquisition of Shang-Wa Electronics. She must determine foreign exchange exposure and implement appropriate hedging strategies. She has to analyze the joint venture capital budget as well as the term sheets for both TEC/Shang-Wa and Avral/Lester proposed acquisitions. The most important job is to create value from the firm’s capital budgeting, financing and net working-capital activities ((Ross, 2004, Ch 6).
“The Net Present Value helps the comparison between the investment and the financial market. One if the most popular alternatives to NPV are either Payback or Accounting rate of return (AAR). AAR is the average net income divided by the average amount invested. (Ross, 2004, Ch 6).
The financing decision, capital budgeting and retained cash flows
Long-Term financing is used to fund the purchase of assets from the merger. The primary sources of capital available to LEI are shareholder’s equity-i.e. money from investors, borrowed funds-i.e. from lending institutions or other sources, and reserves-i.e. profits that have been put back into the business. Though the firm can rely on internal sources, these are usually insufficient to meet investment needs, so the CFO may be compelled to look for external funding sources. Other long-term financing options include the issuance of common and preferred bonds ((Ross, 2004, Ch 1).
“Companies raise cash to finance their investment an activity is by selling or issuing securities.” This cash is invested in the investment activities of the firm and retained cash flows are reinvested in firm (Ross, 2004, Ch 1).
A stock provides two kinds of cash flows dividends and ultimate sales price, which is determined by what future investors expect to receive in dividends.
LEI and Shang-Wa are manufacturing organizations that have been doing business together for over 35 years. LEI and Shang-Wa have opportunity to develop synergy that will benefit them financially while maximizing shareholder wealth. Preferred stock has some of the features of debt and some of the features of equity. Most stocks pay dividends on a regular basis. If Lester is successful, the new owners reap a larger portion of rewards than they would if they had sold in the company to investors to finance the growth. A firm will be acquired in a merger,