Star River Electronics Ltd.

[pic 1]

        STAR RIVER ELECTRONICS LTD.

David Bruner

Curtis Chan

Ericka Lopez

Matthew Vu

Dr. Paul Karmas

Business 440

July 30, 2015

On July 5, 2001, Adeline Koh was promoted as new CEO of Star River Electronics Ltd. after the previous president and CEO had resigned to accept another CEO position with another firm. Star River Electronics is a small manufacturer that supplies CD-ROMs and DVDs for major software companies.

Star River quickly became one of the top manufacturers of these high-quality discs. During the mid-1990s, the popularity of optical and multimedia products created a rapid growth environment for CD-ROM manufacturers. This created a surplus that pushed prices of optical and multimedia products down as much as 40%. Since Star River Electronics has a strong reputation, the company’s volume sales have grown at a strong rate in the past two years, while other CD-ROM manufacturers have struggled. However, the unit price has decreased due to low price competitors and substitute products such as the digital video discs (DVDs).

Star River Electronics decided to test how manufacturing DVDs could help with the company’s sales, but those initial sales accounted for less than 5% of revenue at the fiscal year-end 2001.  With the hopes of increasingprofits from DVDs, Adeline Koh met with her assistant, Andy Chin, to begin addressing some of the issues facing the company.

Assess the current financial health and recent financial performance of the company. What strengths and/or weaknesses would you highlight to Adeline Koh?

By examining Star River’s income statement, we were able to observe the continual increase in sales, which should be positively reflected in the net earnings. Although there is the steady growth in sales, the net earnings dropped to its lowest point of $4,889 in year 2000 due to production cost increased of 20.1% and administration and selling expense increased of 19.8%.  Inventory increased substantially by about 49% in year 2000, almost double by 26,166. Gross Fixed Asset steadily increased by 15-17,000 each year. Liabilities and Stockholder’s Equity percentages shows, Short-Term Debt has trended upwards while A/P, and Equity have trended downwards.

All liquidity ratios are less than 1, which suggest insufficient cash to cover short-term solvency. Current ratios have trended upward, but all other ratios such as Quick and Cash are relatively low, while NWC ratios trended downward to negative. It makes sense that the liquidity ratio would be low since short-term debt is included as part of current liabilities. Star River has a liquidity problem because current liabilities outweigh their current assets, which needs to be corrected before the company experiences financial distress.

Most leverage ratios have trended upwards which is a sign of Star River becoming risky. Debt, D/E and Total Debt to Capital ratios have all increased. Looking at the D/E ratio you can see there was a decent percentage jump between ‘99 and 2000. Short-Term Debt borrowing almost double in 2000 by $35,929, which can indicate that short term debt, is being used to finance long term assets. The TIE ratio indicates Star River has enough operational income to cover interest expense, despite the downward trend, a -.66% drop from ‘99 to 2000. Management should keep an eye on the TIE ratios due to its inconsistency.

Total Asset Turnover trended downward while Fixed Assets upward. The upward trend from Fixed Assets is a positive insight; the company is able to generate sales for every dollar in assets own. The growth in Inventory is further support by the upward trend in ‘Days in Inventory ‘and ‘Inventories to COGS.’ It takes Star River over four months to collect receivables, and they pay off their payables a month sooner to receivables.  All three Days: receivable, inventory and payables results in an upward trend of Cash Conversion cycle from 256 days in ‘99 to a little over a year in ‘00, this suggest cash erosion.

Forecast the firm’s financial statements for 2002 and 2003. What will be the external financing requirements of the firm in those years? Can the firm repay its loan within a reasonable period?

The financial forecast for year 2002 and 2003 is calculated through the percentage of sales method which illustrates an issue with the production cost and expense percentages, and the short term debt. The production expense accounts for 50% of sales, which has been increasing since 1998. This supports the idea that the company needs to invest into new equipment to reduce their production expenses, but investment into new equipment will be difficult with the company’s current financial problem. After forecasting the next two years, the imbalance between total assets, and total liabilities and stockholders’ equity required performing an iteration test to figure out what additional funds were necessary. With the Star River’s projected growth to be 15% in 2002 and 2003, additional funds needed amounts to $17,344 in 2002 and $15,148 in 2003. The company will need to borrow additional funds to fuel its projected growth; Star River has been borrowing short-term, thus we assume that’s how they will continue borrowing. The sharp increase of short-term debt in year 2000, along with the additional short-term debt needed in year 2002 and 2003 would mean they are most likely unable to repay their loans in a short-term period.  They have outstanding leverage trending upward with liquidity ratios trending downwards and will probably decrease at a faster rate than present.

The company has an 11% sustainable growth ratio, but is expecting 15% sale growths, which mean Star River will have to reduce payout, raise new equity or increase leverage. If Star River opts the first two options they will be able to maintain or lower their D/E ratio, while increasing leverage this means debt will increase faster than D/E ratio constant would allow.

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 company’s future financial performance is heavily driven by the amount of short-term debt and production cost and expenses that the company has not been able to reduce or stabilize with their projected growth rate of 15%. The production cost and expense consumes 50% of their sales because the packaging equipment is well over its useful age and is causing the production line to be very inefficient. The best direction would be to retire this old machine and purchase a new machine to improve the efficiency and reduce the cost of maintenance and overtime wages. Replacing the equipment would prove difficult because of the financial situation the company is facing regarding its ability to repay their debt. The amount of short-term debt is the problem and another key driver of the firm’s future financial performance, which has been increasing exponentially since year 2000. The company needs to look into other forms of financing such as the use of more long-term debt, or requesting parents companies New Era Partners and Starlight Electronics to provide additional equity financing to support their long-term assets. Their current financial situation would make it fairly difficult to acquire more financing from banks because of their inability to pay down their current loans. If Koh focuses on acquiring less costly financing, then the production cost could also be reduced, this would ultimately improve the financial health of the company.