Optimizing Capital Structures

Introduction

LEI, Inc. a public company, has decided to acquire Shang-wa, a Korean based company that manufactures capacitors in a vertical integration. The CEO of LEI has convinced the shareholders that this move is a necessary one to avoid the takeover of Shang-wa by one of LEI's competitors, Transnational Electronics Corporation (TEC). Shang-wa has historically represented 43% of LEI's revenue stream. As result of the Board's approval to move forward with the acquisition, LEI must determine which financing alternatives they wish to use to complete the acquisition. The benchmark studies included in this document illustrate several pertinent alternatives to be considered. They include reviewing the financing mix that will optimize the capital structure of the new firm; the weighted average cost of capital considerations in financing; evaluating a dividend policy; and analyzing the risks associated with various financing considerations such as executive stock options and conducting an IPO.

Recommend a Financing Mix that Optimizes Capital Structures

There are many methods for a business to raise needed funds. Typically a firm is not financed 100% by debt. The balance of debt and equity is one of the most basic and important financing questions to be addressed by any business. Use of stocks and bonds as financing options can play an integral part of any organization. These programs become a significant part of a company's capital structure and an important part of business valuation from future investors. As companies expand business capital needs increase for some period to cover costs. The need for any increase in capital can place pressure on a company's overall capital structure. Lester Electronics is now facing these same issues as they attempt to secure financing alternatives. LEI must find a financing mix that allows for optimization of capital structure. One of the included case studies, Domino's, highlights how the use of stock options in a repurchase option, reclaimed 13.9 million shares of common stock which eventually led to a share price increase of 11% for Dominos. The use of bonds, another option within a financing mix optimization, is illustrated in the case study related to Cingular. This study illustrates how the use of a combination of issuing bonds along with other financial strategies accomplished the funding that Cingular required to complete a merger successfully. Flowserve, in their acquisition of Ingersoll Dresser Pumps, demonstrates the importance of balancing debt and equity. In this example, a heavy debt load stressed the company's ability to meet payments when the market contracted unexpectedly