Lester Electronics Financing Alternative

Lester Electronics Financing Alternative Financing

Lester Electronics Incorporated (LEI) a United States (US) capacitor distributor and Shang-wa Electronics, a South Asian capacitor manufacturer have had a contract for over 35 years to manufacture and distribute capacitors both in the US and South Asia. The agreement however is in jeopardy with the recent inquiries of two companies Avral Electronics and Transnational Electronics Corporation (TEC) wanting to possibly acquire LEI and Shang-wa. If this occurs however, LEI stands to lose over 40% of its income because the agreement would be nullified with an acquisition. However, because LEI and Shang-wa's owners are friends as well as business partners they have determined to merge their companies. This will protect the interests of LEI and Shang-wa and will less the threats from Avral and TEC (University of Phoenix, 2007).

Because of the merger, the new LEI with Shang-wa will need to determine the best financial alternative mix to find the best optimal capital structure while maximizing shareholder wealth. This paper will address this issue by benchmarking other companies both in the electric components and capacitor industry as well as companies outside the industry to help them determine the optimal capital structure for the new LEI. This paper will explore weighted-average cost of capital, a financing mix that optimizes structure, analyzing risks associated with investment decisions, and evaluating dividend policy on wealth maximization and benchmark companies to help in this important decision making process.

Weighted Average Cost of Capital

The weighted-average cost of capital (WACC) is a formula that helps a company to find out how much the company is spending on interest on all its financing activities such as stockholder's equity both common and preferred, as well as bonds. Each financing activity whether from debt or equity has a cost. The WACC formula helps a company as well as creditors and investors to see how much the finance activities are costing the company.

A company wants to see a low WACC; and generally a company can withstand a debt to equity mix up to about 50% without having a real problem. In fact a company may even lower their WACC by utilizing more debt. However, there comes a point when the debt will raise all costs causing the WACC will begin to rise called a 'U' affect (Block & Hurt, 2004). This increase in WACC is what a company wants to avoid as it will affect not only costs increasing but also the investors will become quite upset.

One thing to keep in mind however is that different industries will have different WACC that is considered normal within that industry. This depends upon the level of debt acceptable for that industry. For example, airline companies have very high rates of debt even above 80% whereas software companies are generally around 30% (Block & Hurt, 2004). The following two companies will demonstrate this debt to equity mix and how the weights of each help determine the financial health of a company.

American Capacitor Corporation

The American Capacitor Corporation conducts their business in both traditional designs for electronics while also providing specialized or catered designs to other companies. Specially made and low cost custom capacitors are their specialty. Starting in 1979 and located in California, American Capacitor Corp provides film capacitors that supply all dielectronic systems (ACC). This system is defined as a substance in which an electric field can be maintained with a minimum loss of power (Dictionary.com, n.d.). These systems include Super Metallized Polypropylene, Metallized Polypropylene, Polypropylene & Foil, and Polycarbonate & Foil, just to name a few substances (ACC).

Although they are a single location company, American Capacitor Corp generates gross annual sales of $1,300,000. They provide their services to a variation of other organizations throughout the entire west cost area of the United States, including a variation of areas throughout the country. They utilize the most modern equipment in a controlled atmosphere during development of their products to ensure high quality manufacturing (ACC).

Experiencing some of the same issues as Lester Electronics experienced; American Capacitor Corp had to develop a game plan that would allow them to utilize the entire area of the west cost for the business activities. Because they are a single location manufacturer, this made it almost impossible to branch out into other territories.

In order to combat these strikes against them, American Capacitor Corp decided to change the way they offered their products. Instead of just making a general brand of capacitors, they decided to create specialized inventory for those companies that desired something different. Only did they provide customized capacitors, but they also provide this item at a low cost, specifically, whole sale prices. The have even developed a way where future customers can simply send in capacitor requirements or prints and their products are custom made and developed with their input every step of the way (Dun & Bradstreet, 2007).

Panasonic

Panasonic originally began as Matsushita Electric Devices Manufacturing Works in 1918 by Konosuke Matsushita (Matsushita Electric Industrial Co., Ltd., 2007). Eventually it incorporated and became Matsushita Electric Industrial Co., Ltd. in 1935 (MEICL, 2007). The Panasonic name did not appear until 1985 when Matsushita wanted to raise money in the United States (US) by issuing commercial paper... Panasonic was born (MEICL, 2007a).

Like Lester and Shang-wa in the scenario, Panasonic was the beginning for Matsushita to move into the US distributing its capacitor technology, electronic components, and products (University of Phoenix, 2007). This global company established Panasonic first as a finance company issuing short-term bonds and commercial paper. It was so successful that it became the highest rated short-term bonds by two US companies. Within a month the commercial paper was worth 10 million US dollars. Panasonic's short term bond rating was helped by its long-term bond rating of AAA helping to make the short-term bonds quite popular. This was comparable to the ratings of many other first-class global corporations.

LEI and Shang-wa already have the US/SA (South Asia) connection with their 35 year history giving them an advantage that Panasonic did not have. By making the US/SA connection, both companies are strengthened increasing their value. This affects the weighted-average cost of capital. As stated previously the lower the percentage the greater the value. The weighted-average