Financing Alternatives

Financing Alternatives

Lester Electronics (LEI) is in a position to acquire Shang-Wa Electronics. LEI is investigating several different financing options in order to make the acquisition profitable for both companies. Financing alternatives that are being considered are: issuing common stock, issuing preferred stock, issuing bonds, or a mixture of the three options. The purpose of this paper is to introduce the advantages and disadvantages of each financing option as it relates to this particular acquisition and an analysis of the financials of the combined company.

Common Stock

The primary advantage of common stock is that it places a minimum of constraints on the company that issues the stock. In addition, there are no required dividends, and it immediately increases the firms borrowing power. The primary disadvantages if common stock is there is a potential for dilution of earnings for initial investors and ultimately, a loss of control for the original investors. (humbolt.edu, 2007).

As the CEO of Lester Electronics, Bernard Lester will have to give up control to investors in order to issue common stock. In addition, issuing common stock can send negative signals to the marketplace. The primary advantage for LEI to issue common stock is because it would provide an immediate influx of funds to the company in order to secure the acquisition of Shang-Wa. With the combined profit margin increasing from .03 in 2002 to .08 in 2004, that the combination of LEI and Shang-Wa would be a stock that investors would feel was a stable investment. In addition, it appears that return on investment is also increasing. (exhibit A) However, if LEI uses common stock as its sole alternative for financing, the company will dilute its own shares for its initial investors and the value of the stock will fall.

Exhibit A

RATIOS 12/31/2001 12/31/2002 12/31/2003 12/31/2004

Profit Margin 0.03 0.07 0.08

ROA (ROI) 0.03 0.06 0.11

Preferred Stock

The primary advantage of preferred stock is that preferred stock shares are not used when calculating earnings per share for investors. The primary disadvantage of preferred stock is that dividends will have to be paid annually to investors. The primary advantage for LEI to issue common stock is because it would provide another source of immediate funds to the company without diluting the combined company's earning per share, thus still making common stock viable in the marketplace. However, the combined company will then have to pay dividends annually.

Bonds

Bonds just as stocks have their share of pros and cons. The main advantage to bonds is that investing in debt is safer than investing in equity. If a company was to go bankrupt, debt holders more than likely have some money paid back to them. A stockholder has no guarantee to get anything paid back. U.S. government treasury bonds are considered a "risk free" investment; there are no stocks that are considered as such. If your goal were to never