Gap Analysis Lester Electronics

Running head: GAP ANALYSIS: LESTER ELECTRONICS

Gap Analysis: Lester Electronics

Mia Randle

University of Phoenix

Gap Analysis: Lester Electronics

In 1978 Lester Electronics, Inc. (LEI) entered into an agreement with Shang-wa Electronics (SE) to develop an exclusive capacitor distribution contract (University of Phoenix, 2007). The agreement stipulates that SE will provide LEI the right to sell SE capacitors in the United States for 65 years. The agreement requires LEI to sustain a minimum annual purchase of $1 million and in return SE will not sell the capacitors to competitors within the United States (University of Phoenix, 2007). The agreement has been in effect for 35 years and has proven to be beneficial to both parties. Recent events have required SE and LEI to revisit their current business arrangement and the management team of LEI must carefully analyze their current financial position and long-term goals with the purpose of creating growth for the company. LEI is currently pursuing a merger opportunity with SE and seeking appropriate methods of financing the venture. The merger �refers to the absorption of one firm by another. The acquiring firm retains its name and its identity, and it acquires all the assets and liabilities of the acquired firm. After a merger, the acquired firm ceases to exist as a separate business entity,” (Ross, Westerfield & Jaffe, 2005, p.797). With the completion of the merger LEI and SE would establish combined financial and corporate initiatives that will include maximizing shareholder value simultaneously meeting to the needs of customers, suppliers and employees. The financing of this purchase will have a profound impact on the long-term health of the company and investor faith in the organization. The facets of this merger must be evaluated and adjusted to maximize shareholder wealth, and properly address long-term and medium-term financing options.

Situation Analysis

Issue and Opportunity Identification

LEI specializes in the distribution of capacitors and SE specializes in the production of capacitors. The coordination of these �closely related activities’ is referred to as vertical integration of economies (Ross, Westerfield, & Jaffe, p. 803) The completed merger will provide internal cost effectiveness with the supplier being with the distributor and produce an additional cash flow to assist in cost cutting features (Ross, Westerfield, & Jaffe, 2005). There are several opportunities and risks associated with mergers. Mergers are less expensive avoiding legal and accounting difficulties yet mergers must be approved by the stockholders of each company. The tax and accounting issues fostered in a merger are that the type and amount of taxes is dependent on the value of the acquired firm’s assets. Revaluing the acquired firms assets to obtain equal value to the acquiring firm is favorable to avoid the capital gains tax. Tax reduction methods due to net operating loss and other tax benefits are also available as cost reductions. (Ross, Westerfield, & Jaffe, 2005, ch. 29). Accounting methods can vary for acquisitions and mergers. A firm can report assets at the fair market value as opposed to the cost of the asset (purchase method) or combining the balance sheets without accounting for a premium paid for the acquired company referred to as the pooling interest method. (www.aicpa.org) The merger poses to provide synergy for the two companies. Synergy is the combined value of two companies less the value of the two firms separately. Synergy comes from cost reduction, revenue enhancement, tax reduction and lower cost of capital. Revenue enhancement and cost reduction can both increase the profitability of a merger. A merger between LEI and SE has the ability to create synergy and make a stronger company from the two individual companies and the realized growth should be a consequence of the decision to maximize shareholder value (Ross, Westerfield, & Jaffe, 2005). While synergy will assist with increasing the value, the merged global entity will be required to integrate the cultures of Korea and America and overcome any language barriers that may exist. The differences in cultures must be addressed by both companies and be remedied to ensure that the merger is successful. Upon proper cultural integration and assimilation, both companies operations will be able to effectively execute the merger.

“The basic elements of financial planning comprise (1) the investment opportunities the firm elects to take advantage of, (2) the amount of debt the firm chooses to employ, and (3) the amount of cash the firm thinks is necessary and appropriate to pay shareholders. These are the financial policies that the firm must decide upon for its growth and profitability,” (Ross, Westerfield & Jaffe, 2005, p. 399). The merger will require a significant capital outlay by LEI therfore financial planning for the undertaking must be considered. This planning includes an examination of the company's current financial situation and the available means of middle and long-term financing to determine the ideal financing plan for the company. The financing options available to LEI include issuing new stock, issuing convertible bonds and obtaining a loan. Convertible bonds can offer some protection against mistakes of risk evaluation for the company (Ross, Westerfield, & Jaffe, 2005). The dilution of stock should be considered if LEI plans to issue new stock because it will affect the managerial controlling interest of the company.

LEI should analyze whether there is enough financial capacity to carry out the merger with SE. The financial team of LEI and SE will evaluate the company’s cash flows to decide if funds are available to merge with the incurring any debt of SE (Ross, Westerfield, & Jaffe, 2005). If LEI merges with SE using a debt instrument, the financial team will need to ensure that the timing of the cash flows will allow LEI and SE to make the principal and interest payments on the debt. Considering SE has more debt than LEI, LEI will need to finance the merger through working capital and the acquisition of stock. With the successful completion of this evaluation, LEI and SE would be able to increase its financial standing within the industry (Yeldar, 2006). Identifying the short run, long run, the best-case scenario, options, and feasibility of the plans will aid in the optimal decision