Star River Electronics Case Solution

Topics: Financial ratios, Financial ratio, Free cash flow Pages: 14 (3049 words) Published: October 24, 2011
Florida Atlantic University

Star River Electronics Ltd. – Case Analysis

Case Summary

Star River Electronics is a joint venture company that has gained respect within the industry for producing high quality CD-ROMs to major software companies. In the mid 1990s, multimedia products created a high demand for CD-ROMs, allowing manufacturing companies of all sizes to enter the market. As a result, an oversupply ensued causing prices to decline as much as 40%. Star River survived a period of consolidation, and now faced a new threat.

DVDs are alternative storage devices that offered 14 times more storage capacity. Surveys showed that DVD disc drives would increase from 7% to 59% of all optical-disc-drive shipments by 2005. Star River Electronics began experimenting with DVD production but it only accounted for less than 5% of its sales in 2001. With an increase in capacity, Star River hoped that revenues from DVDs would increase.

Newly appointed CEO Adeline Koh is faced with decisions that will have significant financial consequences. Most notably, Koh is seeking an extension on a loan from Star River’s bank. In order to make a case for itself, Koh has appointed her assistant, Andy Chin, to evaluate the company’s historical financial statements and forecast the company’s performance over the next 2 years. In the forecast, Koh assumes that company sales will grow 15% annually, any external funding will come from debt, and also commits to the purchase of DVD manufacturing equipment. The goal of the forecast that will be presented to the bank is to prove that Star River can repay its loans and has not “grown beyond its financial capabilities”.

The following analysis will determine whether Star River has been managing its debt effectively, whether they can assume additional debt, any alternatives, and recommendations to operating and financial changes.

Case Analysis

The analysis will comprise of historical data and ratios incorporating the assumptions laid out by Adeline Koh in the case that: 1. Sales will grow by 15%.
2. External funding is in the form of debt.
3. Capital Expenditures = SGD54.6 million for DVD manufacturing equipment. 4. Interest expense will include 6.7% short-term interest rate, and 14.5% long-term interest rate plus the bond interest rate. 5. WACC = 10%. [1]

Historical Analytical Financial Ratios

Liquidity ratios are examined below in Table 1. The current ratio increased from .76 in 1998 to .88 in 2001. This increase is due to the addition of assets, improving Star River’s liquidity. The quick ratio decreased from .41 in 1998 to .34 in 2001. This decrease was caused by an accumulation of inventory, which is excluded from the quick ratio calculation. The difference between the two ratios continues to increase from .35 in 1998 to .54 in 2001 proving that an inventory problem may exist.

|Liquidity Ratios |1998 |1999 |2000 |2001 | |Current Ratio |0.76 |0.77 |0.80 |0.88 | |Quick Ratio |0.41 |0.41 |0.31 |0.34 |

Table 1 - Liquidity Ratios

Efficiency and debt ratios are examined below in Table 2. Star River experienced a declining trend in total asset turnover from .65 in 1998 to .57 in 2001, a difference of .08. A cause for the declining asset turnover can be a weak inventory turnover ratio. The inventory turnover ratio reflects a declining trend from 1998 (1.45) to 2001 (.84), a substantial difference of .61. This suggests that Star River went from replacing their inventory 1.45 times per year to only .84 times per year. Star River’s debt to equity ratio is increasing from 1.13 in 1998 to 2.20 in 2001. This...
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