Consolidated statements for Lester Electronics Inc and Shang-wa Electronics for 2003 and 2004 show a net worth growth from 6. 8% to 11. 2%. Investments in property, plant and equipment were successful, yielding $44,812. 25 in retained earnings for 2004. Choices for financial capital will now be deciding the future. For example, suppose the merger creates trouble due to unforeseen currency exposure.
A limited debt capacity may require the issuance of equity issues. New potential decreasing cash flows from dividend payments and loss of firm value could hurt the project.Therefore, using the External Funds Needed Formula (EFN) to estimate financial planning needs will reduce the exposure risk due to debt-equity components. Using the financial data (actual and forecasts) from 2004 and 2005, the external funds needed are $30,429. 04.
With this knowledge, retained earnings became a favored option for capital expenditures. “Each firm chooses its leverage ratio based on financing needs. Firm’s first fund projects out of retained earnings.This should lower the percentage of debt in the capital structure, because profitable, internally funded projects raise both the book value and market value of equity” (Ross et al.
, 2005). Short-term financing decisions will decide the long term competitive positioning. Even the most informed forecasts require optimal balancing techniques to survive ongoing operational and cash cycles. Thankfully Lester and Lin can use the historical financial knowledge of the company to close the gap between the inflows and outflows of cash.Closing the gap between inflows and outflows of cash is imperative to settle any short-term obligations of the organization. “Value creation depends on cash flows” (Ross et al.
, 2005). The aforementioned discusses the long-term financial planning is also connected to firm value. The next section will review the long term financing options when external funds are needed.
Common stock, preferred stock and long-term debt are the main alternatives used when internal resources are limited. Equity issues (common stock) are sold to the public in exchange for capital is used to invest in the firm’s projects.Generally, securities (stocks) have no claim to dividends or legal rights for payment upon bankruptcy.
Dividend payments, however, is viewed as a decrease in cash flow when a set dividend policy is established. Under these circumstances, companies often prefer issuing secured and un-secured bonds. Secured bonds (indentures) protect the bondholder in the event of a default, however, still allows the firm to benefit from the tax-deductible interest payments. Companies also often cleverly issue preferred stock (called hybrid securities) possessing the advantages of debt and the limited liability of equity.”For example, suppose a 50-year old bond is issued with interest payable solely from corporate income if and only earned, and repayment is only subordinate to all other debts of the business. Corporations are very adept at creating hybrid securities that look like equity but are called debt” (Ross et al. , 2005).
Ideally the merger should focus on using internal financing to fund projects. That is, after the initial manufacturing facility is established. Beginning stages may require the use of debt or equity issues, supplemented by retained earnings capital. ConclusionThis paper has discussed the importance of critical thinking when developing a financial plan. This paper means to effectively correlate value creation to trade-off decisions. Many options exist for capital budgeting and financial planning, however, each situation requires investigation as to the sources and effects of informed decision making.
The merger should have a “growth target with an explicit linkage to creation of value” (Ross et al. , 2005). Creation of value is the primary focus, achieving minimized variability from thoughtful evaluation of essential tradeoffs.