Star River Case Solution
Case brief and emerging issues
Star River is the manufacturer of high quality optical discs as a supplier to move video games and movie studios producers. The company was established as a joint venture between Starlight Electronics Ltd and New Era Partners. It has been enjoying a great deal of success due to its large part of the excellent image and reputation in the market for manufacturing high quality discs. Adeline Koh – the new CEO at Star River, is concerned about whether to invest in the new packaging machine which would reduce the cost of labor and would help in sustaining the operations of the company. The company needs to decide to either purchase the machine on immediate basis and save the additional cost of SGD286, 878 or wait for three years, which in turn would spur the cost of machine by 5 percent and would increase the cost of maintenance at the same level. Additionally, the company is concerned about taking loan to finance for the new machine, to achieve the desired outcomes.
Current & recent financial health / Strengths and/or weaknesses
Taking under consideration the sales pattern of the company; the sales have increased from SGD71924 in 1998 to SGD106042 in 2001; whereas, the operating profit has also increased from SGD13412 in 1998 to SGD17059 in 2001. The continued increase in sales of the company is reflected in its net earnings. Additionally, the expenses and cost of the company have increased as a result of the old packaging equipment having frequent shutdowns for repair, and forcing the company to make its staff work overtime. The property plant and equipment have also increased from SGD64611 in 1998 to SGD115153 in 2001, while the production cost continued to remain high, thus indicating that either the company does not wisely invest to lower its production cost or it overspends on equipment which tend to generate high property tax.
In addition to this, all the liquidity ratios, including: current and quick ratios are less than 1, which shows that the company has insufficient cash to cover the short-term solvency. The trend of the current ratio is upward, but the quick ratios are declining from one year to another. Thus, the reason of the low liquidity ratios is that the short term debt is included in the company’s current liabilities. The company is experiencing liquidity issues because the current liabilities outweigh the company’s current assets, which must be addressed in timely manner before the company experiences the financial distress.
Furthermore, all leverage ratios of the company, including: debt to equity, debt to total capital and EBIT to interest ratio trended upwards, which shows that the company is becoming riskier than before. The high debt to equity ratio indicates that the company is aggressive in financing its growth with debt. Also, an increase in high debt to capital ratio stipulates the weak financial strength of the company, on account of the fact that the cost of debts might weigh on the company and might lead it towards default risk. Additionally, the company is experiencing problem in collection of receivables, shown by an increase in days of receivables which ultimately lead the company towards the cash flow problems.(Mimick, 2019).
The company is experiencing shortage of cashbecause of an increase inthe account payable as well as the account receivables. The cash flow of the company is unable to fund the company’s daily financial needs, such as: payment to the suppliers. The problem of cash shortage could stem from the reason that the company is having a hard time in collecting the payments from its customers. The company would be able to decrease the expense of interest if collections are made efficiently. Another weakness lies in the fact that the company needs to borrow money for its current business operations. This, when combined with the capital expenditure need followed by the purchase of new packaging equipment, would increase the borrowing of company, which have already increased to large extent from 1998 to 2001. The operational inefficiency of the company is reflected by a decrease in return on sales from 8 percent to 6.7 percent, in 2001.
In contradiction to the weaknesses;the return on assets has increased from 5.2 percent in 1998 to 3.9 percent in 2001, indicating towards an efficient utilization of assets in generating sales. Also, the increase in net sales, net operating profit and net earnings also indicate that the company is efficiently generating higher returns, over the period of time.
Financial statements forecast for 2002 and 2003
The financial statements of the company are forecaster for 2002 and 2003 on the basis of various assumptions. The company’s sales are expected to be SGD120692 in 2002 and SGD137366 in 2003, whereas the expected total operating profit would be SGD20018 in 2002 and SGD23519 in 2003. In the similar way, the net earnings of the company are expected to be SGD14078 in 2002 and SGD16540 in 2003. These values reflect the prospects of the future growth and profitability of the company.
With the CAGR of 13.4 percent of sales; the company would not be able to cover the amount of loan because of the fact that the company’s total liabilities outweigh its total assets, due to which the company would require SGD44476000 in 2002 andSGD17662000 in 2003.Such amount of external financing indicates that the company would not be able to pay off its debt obligations that it would be signing, in the long run due to the fact that the high amount of debt on balance sheet creates the possibility of default risk. The situation would make the banker reluctant to grant the loan amount to Star River. If the company continues financing its business operation through borrowing; Star River would not be able to repay its loan within a reasonable time period………………….
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