FIN42080 Star River Electronics

Pro Forma Balance Sheet

Pro Forma Ratios for 2002 and 2003

Firm payment of loan

No, the firm would not be able to pay its loan because to achieve the 15% sales growth rate and all the changes which that would bring, Star River will require 17. 344 million SGD in 2002 and 30.659 million SGD in 2003. This amount of external financing needed does not seem to indicate that the company would be able to pay off any loans that it will be signing in the near future due to its requiring of financing, most likely more debt, to reach its maximum growth rate.

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?

The core assumption for this model is the growth rate of the company. Because the expenses are almost entirely varied with the growth rate in the model, should the growth rate fall short of the projected 15%, Star River Electronics would be in big trouble. This is also highly possible since the market is moving away from CD-rom’s and now even moving away from DVD’s and there is a chance they may suffer from technology obsolescence. Additionally, the interest expense is assumed to remain constant. Therefore, it is assumed that no new debt in incurred. This is important because if the growth rate is less than the projected 15% and the company still sends more, as if sales went up dramatically, the increase in interest expense would be a very big deal. Additionally, the dividend payout (2,000SGD per annum) is assumed to be fixed. Should the net income be less than projected, again due to a sales projection miss, the retained earnings portion of the balance sheet would miss its projection and hurt some of the projected ratios.

Other key drivers and assumptions of the company’s financial health are that there must be a reduction in production costs and debt, which includes replacing the old production machines with newer ones. The company should use comparative analysis to help determine when they should buy the new equipment since it will be a hefty purchase. To reduce the company’s debt, they will need to stop issuing dividends for a while. Although this seems like a positive, it is hurting the company because that money could be better used to pay off debt. The company should also collect its account receivables that customers owe of about $5,486. The company must also reduce inventory by stopping production for a short time so that the company can reduces its short-term loans which were being using for holding inventory. The company should also focus on equity financing instead of debt financing to help reduce interest payments and loans.

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?

The weighted average cost of capital for Star River Electronics was 10.64%%. We arrived at this by using a MV/BV multiplier as a proxy for the market capitalization, since this is a private company. Additionally, we assumed that the book value of debt is also equal to the book value. The multiple for MV/BV was calculated by taking the average of the premium that Star River’s closest peers were trading at relative to their book values. For the closest peers, we used Wintronics, Inc, STOR-Max Corp, and Wymax, Inc. We used these because they were the three companies that had the majority of their business in CD-ROMs and DVD Production, making them the closest peers. We calculated their market capitalization by taking the shares outstanding and multiplying it by the share price. We calculated the book value the same way. The math is summarized in the chart below. MV/BV Multiple = 3.41x = $3941/$1156.

Weights of Debt vs. Equity

Using the multiple calculated above, the MV of equity was calculated. MV of Equity = BV of Stockholder’s Equity * MV/BV Multiple. In 2001, that would be 47,004 * 3.41 = 160,284. The BV of Debt was assumed to be the same as MV of Debt. Therefore, the MV of debt in 2001 was 103,181 (Long-term debt + Short-term borrowing). Therefore, the weights of the market values of debt and equity were 60.8% equity and 39.2% debt, respectively.

Cost of Equity

The cost of equity was calculated using the average of the betas from the three closest competitors as a proxy for this company’s beta, then the CAPM formula was used. The average beta from the same three companies that were used to calculate the MV/BV multiple were used for this calculation as well. The average beta ended up being 1.58. Therefore, that was the beta used for this company. The 5-year bond from Singapore’s central bank in January 2001 was yielding 3.14%[1]. In the spreadsheet, it said to assume the Singapore market risk premium was in line with the global average of 6%, so we used a risk premium of 6%. Therefore, the formula used to calculate the cost of equity for this company was 3.14 + (1.58 * 6), which is 12.62%.

Cost of Debt

For this calculation, we simply divided the interest expense by the total amount of debt outstanding (Long-term debt + short term borrowing). This formula was…

7.58% = 7,818 / 103,181.

WACC Calculation

WACC = (Weight of Debt * Cost of Debt) + (Weight of Equity * Cost of Equity)

10.64% = (0.392 * 7.58) + (0.608 * 12.62)

Critical Assumptions

The biggest assumptions for the WACC calculation in the MV/BV multiplier and the use of those three particular companies as the proxy for the market information of this company, since Star River is private. However, these assumptions were made to create a more accurate market-based WACC as opposed to a book value based WACC. From these two assumptions, all the other assumptions were derived, namely the beta value for the CAPM equation and the weights of both debt and equity. These are major parts of the WACC calculation so their being derived for two assumptions is worth noting. However, our assumptions are grounded in logic and follow two consistent themes, that market based WACC are superior to book value based WACCs and that Star River should be compared with its peers and only closest peers.

[1] https://www.investing.com/rates-bonds/singapore-5-year-bond-yield-historical-data