Generic Benchmarking - Lester Electronics, Inc.

Generic Benchmarking - Lester Electronics, Inc.

Running head: GENERIC BENCHMARKING: LESTER ELECTRONICS, INC.

Generic Benchmarking: Lester Electronics, Inc.

Anne Groce, Olanike Oyedare, Oluremi Oyedare, Jun Michael Calma

, Brian Barnhart

University of Phoenix

Generic Benchmarking: Lester Electronics, Inc.

Introduction

Most corporate growth occurs by internal expansion, which takes place when organizations existing departments grow through normal capital budgeting activities. However, the most dramatic examples of growth and often the largest increases in stock prices, result from mergers. Many reasons have been proposed by financial managers to account for frequent merger activity. The primary motivation behind a merger is that it provides an opportunity to bring together and increase the value of the combined enterprise.

Realizing prosperity in any organization requires hard work and a great deal of research. One commonly used research tool available to organizations is benchmarking. Benchmarking is the process of identifying, understanding, and adapting outstanding practices from other industries and organizations worldwide. Other companies is look at Benchmarking as a highly respected practice in the business world. Benchmarking is an activity that gives businesses the ability to look outward to find the best practice that fits the organization.

The main concepts discussed in this paper in relations to the Lester Electronics scenario are weighted average cost of capital (WACC), operating leverage, Beta, financial mix, and analyzing risk. Companies used in this paper to relate to the concepts are AT&T, Best Buy, Coca-Cola Company, Exxon Mobil Corporation, General Mills, Microsoft, Starbucks Corporation, and Vontobel Holding AG

Weighted Average Cost of Capital

Lester is in the difficult position of determining the costs and value of its decision to merge with Shang-wa to determine its financial viability. Lester’s initial review of the merger indicates negative Net Income for the first number of years. This means Lester will have to incur some portion of debt equity to finance the transition phase during the merger. Lester would be best off using the Weighted Average Cost of Capital (WACC) method since it is currently using equity to finance the merger and will invariably, use additional debt as well. The following formula is what Lester will use to determine its WACC, however, the weight for debt will be based on a target ratio rather than an actual ratio. Additionally, rs, the cost of equity, can only be estimated since Lester does not currently have next years dividends per share, market value of the firm’s debt, or the current market value and will instead use the current years values (2004) gathered from the income statement provided in the example.

rWACC (Lester) = ((.71 / (.71 + .5)) 2.74) + ((.5 / (.71 + .5)) .1) * (1- .34) = 1.64

Since Lester has had a growth rate of over 200% in its stock earnings per share each year it seems there is little incentive to use any debt equity, however, the coming years will not have such a successful return and it will be necessary to use debt equity. Lower stock earnings will surely create a higher WACC, which will show a more accurate picture of future costs.

Leverage is a concept that Lester will have to consider during the merger with Shang-wa. Operating leverage is a firms fixed cost of production. Lester has primarily been a distributor up until the merger and has never had to deal directly with production costs. Financial leverage refers to the portion of a company reliant on debt. The interest payments a company makes on the debt is now considered fixed costs. As Lester acquires a certain portion of debt equity, it must include the financial leverage costs into the Operating leverage totals as cost of production. Lester could look to Starbucks as an example of a company who successfully used debt as a catalyst for successful growth. Starbucks plans to expand into the Asian market, effectively doubling its number of locations. Starbucks had to consider the debt incurred by such an undertaking. Fortunately, for Starbucks, they intend to eliminate all debt within a year and a half. Lester might not have the same luxury but can at least look at Starbuck’s financial accounting to determine the accurate was to account for the additional debt.

There are additional items that will have to be estimated since there is no real world