AFIN832 Case study 1: Star River Electronics Ltd
1. Assess the current financial health and recent financial performance of the company. What strengths and/or weaknesses would you highlight to Adeline Koh? From the ratio of profitability, the company had about 18% on operating margin, 16% on ROE, 8% on ROS and 5% on ROA in both 1998 and 1999. However, there was a downturn trend in profitability ratio in 2000. This could be the result of price competition because of the introduction of DVD manufacturing in the market. The profitability ratios rose again in 2001. It shows that the company had ability to recover its ROE and operating margin. If ROA is sound and debt levels are reasonable, a strong ROE is a solid signal that managers are doing a good job of generating returns from shareholders' investments. Increasing sales and assets may also increase the debt of the company. Therefore, Star River needs more concern about the growth of profitability without taking too much debt. We analysis the financial leverage of the company, it shows that the debt to capital ratio and debt to equity ratio had an upward trend between 1998 and 2001. The higher the debt-to-capital ratio, the more debt the company has. It shows that Star River is more prone to using debt financing. It may also show weak financial strength because the cost of these debts may weigh on the company and increase its default risk. The debt to equity ratio increased from 1.13 in 1998 to 2.20 in 2001. A high debt/equity ratio generally means that a company has been aggressive growth with debt financing. This can result in volatile earnings as a result of the additional interest expense. However, the interest coverage ratio of the company looks in good condition. When a company's interest coverage ratio is no more than 1.5, its ability to meet interest expenses may be questionable. Star River’s interest coverage ratio is always higher than 2, so it had the ability to meet the interest expenses. In terms of assets utilization, the company’s asset turnover ratio is decreasing constantly from 65.2% in 1998 to 57.4% in 2001 and days in receivables ratios increased from 112 in 1998 to 122.1 in 2001. Assets turnover is a ratio that shows the efficiency of a company’s use of its assets in generating sales revenue or sales income to the company. Therefore, Star River has become less efficient to generate revenue by using its assets. The longer days in receivables indicates that company need longer time to collect on its sales to customers on credit. Moreover, the assets growth rate fluctuated wildly during the period, 8%, 13.5%, 29.3% and 14.2% over the 4 years. From 1998 to 2001, there was a stable increase in Inventories to COGS ratio. It may be caused by a study predicted the market share of CD-ROM will fall in the future because of the introduction of DVD. Therefore, Star River needs to consider the market change in order to avoid stock obsolescence. The company needs to sell CD-ROM inventories at a discount price. However, the revenue of the company will be reduced or even make a significant loss. In terms of liquidity ratio, current ratio is an indication of a firm’s market liquidity and ability to meet creditor’s demands. The analysis shows that the current ratios of the company are 0.76, 0.77, 0.8 and 0.88 during this period. Moreover, the quick ratios of Star River are 0.41, 0.41, 0.31 and 0.34 from 1998 to 2001. Low values for the current and quick ratios indicate that company may have difficulty in meeting current obligations. Additionally, the sustainable growth rates are the most important figure for the company. The sustainable growth rate is a measure of how much a firm can grow without borrowing more money. As it shown in the table, we found that the sales growth rate of the company is higher than the sustainable growth rates between 1998 and 2001. It means that Star River must use other funds to facilitate growth, which will increase the financial risk....
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