Therefore, WACC will tell LEI the return that all stakeholders can contemplate. In explanation, WACC shows the LEI’s opportunity cost of the risk of investing money into Shang-Wa.
Determining WACC allows LEI two financial solutions to raising funds and shareholder value; debt financing and equity financing offering both medium and long term options.
Equity financing is “a method of financing in which a company issues shares of its stock and receives money in return” (entrepreneur.com, n.d.).The balance sheet of both LEI and Shang-wa shows the configuration of assets and liabilities, the relative amount of debt and equity expenditures and retained earnings. Conjointly, all of this information can be viewed by external parties to help assess the joint companies financial standing before any investors put capital towards the project.
If LEI chooses the equity financing route, it will allow the company to acquire funds without acquiring more debt. As long as the business accrues a profit, the investors will be repaid. LEI can choose to raise equity on a private or public level. Advantages to equity financing for LEI can include the addition of permanent capital which can also be used to make and exchange on equity. This financing approach will create wealth for employees and shareholders, however, there are some disadvantages to using equity. The cost is more expensive than debt financing. It can involve a reduction in EPS as well as sharing ownership of the company. This approach also has the highest maximum risk and highest opportunity risk.
Debt financing involves borrowing money from lenders. This can be either a short, medium or long term approach. Short term loans have a repay time of less than one year. Medium term loans are any loans than are more than one year but less than ten years. Along side are long term loans which are any loans longer than a year, up to thirty years. A characteristic of debt financing is that is has less risk than equity financing to investors and is always guaranteed of capital and interest compensation. In the view of LEI, it will be less expensive than equity financing and the risks are less. Although there is an lower expected rate of return, investors are appeased with the idea of an permissible expense for tax.
In the business world, debt financing is frequently known as issuing bonds or debentures.
LEI can use bonds as an instrument for gaining capital. Rather than borrowing money from a bank, LEI can elect to issue bonds to gain capital for the SE investment. Ross et al. (2005), stated, “One way that companies raise cash to finance their investment activities is by selling or
“issuing” securities.” Other companies will buy LEI’s issued bonds with a promise to repay the principal which is accompanied with a fixed rate of interest, with a specific maturity date. This will leave LEI’s assets to be available to gain other capital.
LEI also has other options in debt financing which include issuing convertible debentures. These can be “converted” into equity. In this case the issuer or buyer of the debenture can decide to have the debenture transferred into stock. The cost of borrowing is less for LEI, since the buyer also has the option of converting into stock.
There are several advantage to using debt financing for LEI. Firt, they are less expensive and is cheaper as compared to the ownership interest as investor and have a lower risk. LEI would not relinquish ownership with debt holders, there are fixed payments of interest and the cash outflows can be foreseen. There also exists a tax shield and an improvement in ROE.
Bonds and other debt financing options can also be a method of leveraging. Leveraging is the relationship between debt financing and equity financing. It can be considered “shorthand” for a businesses ability to get funding (Ward, n.d.). In this manner, the main goal of LEI in applying financial leverage is to heighten the shareholders’ return in amicable economic conditions. Financial leverage plays a role in magnifying shareholders returns and is based on the idea that loans or debentures can be acquired at a lower cost than LEI”s rate of return on net assets.
If LEI chooses this option there are risks that need to be known. LEI’s cost of debt from the different interests of shareholders and bondholders may lead to a high debt financing cost. As debt financing increases, the cost of equity and debt both increase due to financial stress and costs. Eventually more debt finacning will cause the WACC to increase. There also remains the obligation to pay those who bought bonds or debentures. This must occur even if there is a loss of cash or decrease in liquidity. This option could also require a slow leak of cash outflow. Using tools such as public offer shares and convertable bonds, will not weaken LEI’s earnings right away. This approach will also help the debt equity ratio to remain low.
Stakeholder Perspectives/Ethical Dilemmas
Every organization has stakeholders who are affected by every decisions made by corporations.
LEI has various parties who will be affected by the success of this merger. Including in these are
shareholders, investors and current management. Investors are mainly interested in projects or ideas that will accomplish growth. Growth will eventually lead to a higher return on investors money. They will evaluate LEI’s acquisition of SE for future potential on maximization of share value. Investors will want to know their money is in safe hands. They will look at every risk and evaluate their worth in the company. LEI must show them that their money is in the right hands, and that investors will see a great return.
Other members who will be affected by LEI’s merger are the managment board of both companies Power plays a big role in driving the company towards decisions. All members must see how they will benefit from LEI’s acquisition. There is also the threat of power struggle. The managment parties will have to work hard to integerate both coroprate cultures as well as show confidence to the employees.
End-State Vision
Through this new acquisition, Lester Electronics, Inc and Shang Wa Electronics will becoming leaders in their industry. Lester Electronics, Inc.has hope that they will be profitable and improve their value for shareholders and employees. The ideal debt ratio will be one that minimizes the cost of capital for LEI. With the CFO making a sound decision on the optimal capital structure which can minimizes the cost of capital, LEI’s value can be fully maximized. LEI’s capital structure which reduces WACC by using both debt and equity. By increasing revenue, LEI will develop synergies by expansion and growth, reducing cost through operation efficiences, tax shelters and a lower cost of capital. Using financing alternatives, the merger will be completly funded, and shareholder value will be maximized.
Gap Analysis
LEI is a growing, profitable leader in its industry and is developing a vision to expand to new domains. To narrow this gap, LEI will use its experience and power to acquire Shang-Wa in hopes of averting any takeovers. Maximizing profits and increasing revenue, LEI and SE will give all stakeholders to perfect, win-win situation. Mergers are new to LEI, therefore the CFO must develop a financial plan which will use WACC to forecast how much shareholders can expect in return. LEI must deviser the appropriate kind of capital structure which will maximize returns and shareholder value as well as minimal risk. The CFO must also consider any outside factors that will affect the stability and profitability of the merger. In addition, the CFO will look at the combined cash flows to analyze each investment strategy by equating NPV, IRR and PI. “CFO's are critical to this process of deploying capital. Good ones are much more than simply stewards and operators of their companies' financial reporting processes. They are strategists and catalysts for ensuring that capital is applied to opportunities that provide the best combination of reward and risk” (Deloitte, n.d.)
The merger can be financed using a consolidation of debt and equity. Issuing equity such as bonds could decrease earnings per share. If LEI decided to use cash to fund the merger, it is possilbe that this options may add debt reconstruct the debt/equity ratio. As the CFO, it will be important to look at the risks that accompany the financing alternatives. Shareholders and board members desire to see the advantages, scopes of financial strength and plans that LEI has to propose.
Conclusion
All mergers are accompanied by both challenges and opportunities. Synergy can be developed when two merging companies see the maximum value that the two as a whole can reach and making sure that changes in the capital structure will ensure value, which is most important to shareholders. When evaluating the financial needs to obtain wealth maximization, having a sound financial plan is key for any CFO. WACC will show LEI its opportunity cost and funding alternatives for medium and long term options will convince shareholders which plan will provide the ultimate structure, value and shares.
References
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Table 1
Issue and Opportunity Identification
Table 2
Stakeholder Perspectives
Table 3
End State Goals
