Florida Atlantic University

FIN 6806

Cases in Financial Management

Dr. Rainford Knight

Star River Electronics Ltd.

Dianne C. Bradley
Case Summary
Star River Electronics, Ltd., located in Singapore, was founded as a joint venture
company and quickly became a leader in producing high-end CD-ROM’s, which was their main
product. In the mid-1990’s the market became flooded, which drove down asking price of CD-
ROM’s and Star River’s price points. In spite of this, based solely on their reputation, Star River
was able to survive the saturation of the market.
However, the market was seeing a shift from CD-ROM’s to DVD’s, which had 14%
more capacity. In a 1999 study, it was predicted that CD shipments would decline by 41% and
the DVD market would rise by 59%. At the end of 2001, Star River’s DVD sales were barely
5%.
On top of all this, Star River was going through a leadership change. July 2001 saw the
current CEO resigning, with Adeline Koh being named CEO. Star River was facing not only a
change in new leadership, but also a shift in the market and consumer desires.
Due to the above, the remaining paper will cover an analysis of historical financials and
project future financial forecasts, presenting thorough information to provide a variety of
alternatives and based on the history, forecasts, an alternative, and a recommendation will be
made to Star River and Koh as to the financial health of the company.
Case Analysis
This section will analyze Star River’s current financial base on past historical financial
numbers as well as an analysis of projected future growth.
Historical Financial Health
Star River’s Historical financial health is not strong and most of their weak financial
strength is due from and projected from balance sheet items. From 1998 – 2001, their debt to
equity ratio has increase from 1.13 to 2.20 or 93.6%. Their ability to cover their interest is
depicted with the times interest earned ratio, which over four years is only slightly over two
times.

Financial Leverage 1998 1999 2000 2001

Debt to Equity 1.13 1.21 1.99 2.20
Times Interest Earned (2.23 average
four years) 2.46 2.48 1.82 2.18
Table 1 – Financial Leverage Ratios
In reviewing Star River’s asset management ratios in Table 2, one can see there is
trouble. Based on a percentage of sales, year 2001’s account receivables is at 33.46% while the
accounts payable is low at 12.61%. This tells me they are lending too much credit to their
customers and not taking advantage of the credit offered to them by vendors. Since 1998, their
operating margin percentage has decrease and their inventories to COGS have increased
extensively. Both are not good signs.
From 1998 – 2001, cash saw a 5% decline, and account receivables saw a 26% increase
and accounts payable only a 12% increase from 2000. Inventories have increased significantly

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(174%) during the past four years in an industry that will soon be close to obsolete. Star River’s
short term debt has also increased significantly by 193% over four years. This is of concern since
their cash inflow has also decreased.
Star River’s days in receivables have been increasing since 1998 and their A/R turnover
ratio has not increase much over the past four years. This tells me they have a lot of cash tied up
with their customers. In addition to this is their A/P turnover rate. While it has been increasing
over the years, which is good for their credit and the lending institutions like to see this, but once
again, they could be not utilizing the full benefits of the credit provided to them from vendors.

Asset Management Analysis 1998 1999 2000 2001

Days in receivables 112.4 115.6 110.7 122.1
Payables to COGS 36.5% 33.4% 25.6% 25.0%
Inventories to COGS 69.1% 72.1% 115.8% 119.3%
AR Turnover (Credit Sales / AR) 3.25 3.37 3.47 3.34
Inventory Turnover (COGS/
Inventory) 1.45 1.39 0.86 0.84
AP Turnover (COGS / AP) 2.74 3.00 3.91 4.00
Table 2 – Asset Management Ratios
Overall, Star River’s profitability, leverage, asset utilization, and liquidity ratios do not
look much better, with most of these related to the income statement. Out of the four, the
profitability ratios looked the best and saw slight increases. The liquidity ratios in Table 3 are
terrible, but then again, these are balance sheet driven. According to the current and quick ratios,
it Star River is not able to cover their liabilities.

Liquidity Analysis 1998 1999 2000 2001

Current Ratio .76 .77 .80 .88
Quick Ratio .41 .41 .31 .34
Table 3 – Liquidity Ratios
The historical sustainable growth rate in Table 4 below, Star River grew at an average
rate of just over 10% without having to find outside funding, however their compounded annual
growth rate was 13.82% over this same period. Therefore, this tells us Star River was having to
source outside funds and was dependant on debt.
Their free cash flow during this historical period was very unstable. They were able to
increase their Free Cash Flow (FCF) from 1999 to 2000, but then took a drastic decline in year
2001. Analyzing free cash flow is important since this represents the cash Star River is able to
generate cash after sourcing funds to maintain or grow their asset base. Also, this is the cash that
is available for use by Star River to seek opportunities to enhance shareholder wealth.

Cash Conversion Cycle (CCC) measures the time from cash output to cash recovery, or
how long each dollar is held up in sales and production before it is converted to cash. This ratio
takes into account how long it takes to turn over the inventory, receivables, and payables.
Generally, the lower the better. Star River has done a good job over the years in managing this
cycle. However, 2001 could cause concern. They had a negative CCC, which means they were

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getting paid from its customers prior to Star River providing the goods. While an inflow of cash
is good, if they do not manage this early receivable of cash, they could find themselves in a
future cash shortfall.

Star River is not managing their Return on Invested Capital (ROIC) well, and this should
be of concern to the shareholders. It has seen a steady decline and since 1998, has decreased by
40%. This tells me management is not managing the funds very well that have been invested into
the company. Star River’s WACC is 13.90%. In 1998 and 1999, Star River was barely making
money on their invested capital, beginning year 2000, it was costing Star River more to borrow
funds than they were getting on return.

Management of Growth & Cash 1998 1999 2000 2001

Sustainable Growth Rate 10.84% 11.74% 6.90% 10.95%
Over the course of the years, Star River’s
Compounded Annual Growth Rate investment grew from $71,924.00 to $106,042.00 13.82%
Free Cash Flow - $6,680 $8,004 $(469)
Cash Conversion Cycle 1.96 1.55 .25 -.17
Return on Invested Capital 14.09% 13.69% 9.15% 9.14%
Table 4 – Growth and Cash Ratios

WACC 13.90%
Wd 14.06%
We 85.94%
Rd 6.62%
CAPM 15.36%
Tax Rate 24.50%
Table 5 - WACC Calculations
Table 6 below depicts clearly the problems Star River is having with cash flows. From
this statement, we are able to see they are not managing their cash well in operating activities or
in investing activities. We are able to see a significant increase in cash from financing activities,
which supports the fact Star River has been increasingly dependent on financing support for its
operations.

Star River
Statement of Cash Flows
Period ending 1999 2000 2001
Net income 6,576 4,890 7,148
Operating activities, cash flows provided by or used in:
Depreciation and amortization 9,028 10,392 11,360
Decrease (increase) in accounts
receivable (3,216) (2,714) (7,408)
Increase (decrease) in A/P 491 (915) 1,479
Increase (decrease) in other accrued
liabilities 1,722 (1,250) (3,763)
Decrease (increase) in inventories (4,361) (26,166) (9,950)

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 Net cash flow from operating activities 10,240 (15,763) (1,133)
Investing activities, cash flows provided by or used in:
Capital expenditures (15,542) (17,746) (17,254)
Net cash flows from investing
activities (15,542) (17,746) (17,254)
Financing activities, cash flows provided by or used in:
Dividends paid (2,000) (2,000) (2,000)
Increase (decrease) in debt 8,157 35,929 20,092
Net cash flows from financing
activities 6,157 33,929 18,092
Net increase (decrease) in cash and
cash equivalents 855 420 (295)
Table 5 – Statement of Cash Flows
Strengths and Weaknesses to Highlight
On the positive side, Star River’s income statement has been stronger than its balance
sheet. They have been able to increase its sales over the past four years, from $71,924 to
106,042, a 47% increase. While doing so, they have been to maintain steady production costs
and SGA’s. With the exception of year 2000, Star River has posted increases across the board.
While even in year 2000, the gross profit, EBITDA, and EBIT saw increases, which tells us Star
River had higher than normal interest expense, which caused the lower EBT and Net Income.
They were able to regain this loss in the following year.

Income Statement Condensed 1998 1999 2000 2001

Sales 71,924 80,115 92,613 106,042
Gross Profit 38,222 41,723 46,121 52,597
EBITDA 21,489 23,935 24,820 28,420
EBIT 13,412 14,908 14,429 17,059
EBT 7,949 8,898 6,491 9,241
Net Income 5,728 6,576 4,890 7,148
Table 6 – Income Statement Condensed

COGS & SGA Analysis 1998 % of Sales 1999 % of Sales 2000 % of Sales 2001 % of Sales
Production costs and
expenses 46.86% 47.92% 50.20% 50.40%
Admin. and selling
expenses 23.26% 22.20% 23.00% 22.80%
Table 7 –COGS & SG&A’s as a Percent of Sales
However, a major weakness is the company’s dependency on debt in order to fund its
operations and its low liquidity ratios, especially if they are considering purchasing the
packaging equipment. The new CEO also needs to be concerned with increase in inventory
(174%), which coupled with its debt dependency to operate, could also be a contributor to the
short-term debt increase (193%). She also should attempt to increase her receivables rate and

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increase her payables percentage. There is a major weakness in how the balance sheet items are
managed.
Future Analytical Performance
This section will review the forecasted financial performance of Star River based on a
sales growth of 15%, with all other line items increasing as a percentage of sales, and assuming
the new equipment is purchased at SGD 1.82million.
Income Statement Forecasts
Assuming sales will increase 15% for the next two years, Star River will yield net income
of SGD $5.4 and $3.2 million for each year, respectively.

Forecasted Income Statement Condensed 2002 2003

Sales 121,948 140,241
Gross Profit 60,419 69,491
EBITDA 32,614 37,516
EBIT 17,172 18,173
EBT 7,251 4,239
Net Income 5,474 3,200
Table 8 – Forecasted Income Statement – Condensed
However, Koh’s expected forecast of 15% sales growth is aggressive in comparison to
the linear sales trend and linear production trend in Table 9 and Charts 1 & 2. While Koh
predicted 2002 and 2003 sales SGD $121,948m and SGD $140,241m respectively, the trend
shows sales at SGD $116,386m and SGD 129,350m. Forecasted production costs and expenses
were also overstated as compared to the trend line. These numbers could be different for a
variety of reasons, but most likely due to the trend line calculating actual sales and production
numbers where we may assume Koh was hoping for a 15% increase based on prior year’s
performance. However, if this is the case, then she actually overshot her estimate. For the years
1999-2001, the average increase was only 13.83%, which what is depicted in the charts.
With the increase in sales revenues, Star River has seen an increase in Earnings Before Taxes
and Interest (EBIT). However, this affects their earnings before taxes, which creates a higher tax
and lowers net income, resulting in lower retained earnings.

Linear Forecasts 2002 2003

Sales 116,386 129,350
Production 59,840 37,366
Table 9 – Linear Sales & Production Forecasts

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 Sales
120,000
100,000
80,000 Sales
Linear (Sales)
60,000
40,000
20,000
-
1998 1999 2000 2001 2002 2003

Chart 1 – Linear Sales Forecast

Production Costs & Expenses

60,000
50,000
40,000 Production
Linear (Production)
30,000
20,000
10,000
0
1998 1999 2000 2001 2002 2003

Chart 2 – Linear Production Costs Forecast

Balance Sheet Forecasts
Star River’s balance sheet is still heavily leveraged with its inventories and its short-term
debt. Coupled with that is the fact of the new packaging equipment purchase of SGD $1.82
million. If Star River did not take on any additional projects and did not purchase the equipment,
they could continue to operate without seeking external funding. However, their current
equipment is quickly becoming obsolete, requiring additional labor hours and additional
maintenance, therefore for this scenario we are assuming they are purchasing the equipment.
This will require Star River to acquire additional outside funding, as depicted by line item Short
Term Debt in Table 10 below.

Forecasted Balance Sheet   2002  2003 

Assets      
Cash   4,281 4,678
Accounts receivable   46,685 61,418
Inventories   91,796 132,123
Total current assets   142,762 198,219
Gross property, plant & equipment   144,273 171,573

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 Accumulated depreciation   -49,135 -63,529
Net property, plant & equipment   95,138 108,044
Total assets   236,253 299,850
Liabilities and Stockholders' Equity      
Short-term borrowings (bank)1   94,304 104,649
Short Term Debt   37,306 87,771
Accounts payable   15,327 17,571
Other accrued liabilities   20,638 19,981
Total current liabilities   167,575 229,971
Long-term debt2   18,200 18,200
Shareholders' equity   50,478 51,679
Total liabilities and stockholders' equity   236,253 299,850
Table 10 – Pro Forma Balance Sheet with equipment purchase
Loan Payback
Star River will not be able to pay back this loan within a reasonable time frame, and even
with aggressive and creative fund management, they still would be extremely challenged to pay
back the loan. They have two choices to make in paying this back. They can pay it back and still
pay dividends of $2000 or shorten the payback period and use the dividends in assisting with the
payback. Assuming they follow prior year’s trends and pay dividends and assuming they have a
steady growth rate it will take Star River over seventy years to pay back this loan.
Ratio Forecasts – Table 11
In analyzing Star River’s profitability ratios, all have declined with the exception of
Return on Sales. The increase on the Return on Sales is due to the projected 15% sales increase
from the years prior, which were less than 15%. The ROE has decreased due to the increase debt
Star River engaged in.
Leverage Ratios are used to understand a company's ability to meet it long term financial
commitments. For this industry, Star River’s D/E ratio is high. We already know they have been
using a lot of debt to finance their operations, and with the additional CAPEX, they have
increased this even more. A high D/E ratio could be good if the debt is managed properly and
used to generate earnings for the shareholders, however this is not the case with Star River. Also,
Star River’s Interest is not good. This low coverage ratio means they could have some problems
with paying the interest on their debt. We can also look at Star River’s liquidity ratios and see
this is true. They have access to very little cash.
Star River’s Asset Utilization varies from line item to line item. Their asset growth rate
increased from 2001 due to the increase in fixed assets; however, they are still having problems
with inventory, which is evident by their inventory to COGS ratio and their decreasing inventory
turnover rate.

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 Financial Ratios 2002 2003
Profitability
Operating margin (Return on Sales) (%) 14.08% 12.96%
Return on equity (%) 10.84% 6.19%
Return on assets (%) 2.32% 1.07%
Leverage    
Debt/equity ratio 2.97 4.08
Debt/total capital (%) 75% 80%
Interest Coverage (x) 1.73 1.30
Total Debt Ratio 79% 83%
Long Term Debt Ratio 27% 26%
Asset Utilization
Sales/assets 51.26% 45.79%
Sales growth rate (%) 15.00% 15.00%
Assets growth rate (%) 27.79% 26.92%
Days in receivables 22 159.9
Payables to COGS 24.91% 24.83%
Inventories to COGS 149.19% 186.75%
AR Turnover (Credit Sales / AR) 16.55 2.28
Inventory Turnover (COGS / inventory) 0.67 0.54
Days in Inventory 544.54 681.62
AP Turnover (COGS / AP) 4.01 4.03
Total Asset Turnover 51.62% 46.77%
Liquidity    
Current ratio 0.85 0.86
Quick ratio 0.30 0.29
Table 11 – Financial Ratios based on Star River Forecasted growth
Table 12 below tells us that Star River is only able to sustain a growth rate of 7.51% and
4.09% respectively. This is way below Koh’s projected sales growth rate of 15%. In addition,
they are having significant problems with their cash conversion cycle. In 2002, it is too high and
2003 it is too low, which means they are having problems in their accounts receivables, accounts
payables, and inventory.

Growth & Cash Ratios 2002 2003

Sustainable Growth Rate 7.51% 4.09%
Cash Conversion Cycle (x) 13.21 -1.21
Free Cash Flow 9,490 12,250
ROIC 12.65% 8.80%
Table 12 – Proforma Growth and Cash Ratios
Star River’s ROIC in 2002 is still lower than their best years of 1998 & 1999, which
averaged slightly over 14%. During these years, Star River was still generating value on their

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invested capital, compared to their WACC. However, year 2000 began a decline, and even thoug
2002 saw a slight increase to 12.65%, it still is not enough to cover their costs of capital.
Management of Star River are not effectively doing their job and not creating value or
shareholder’s wealth.
Alternatives

 Continue in the current CD-ROM Market

 Move full forward into the DVD Market

 Split from New Era and become its own entity

Recommendations
Splitting from New Era would not be a good idea. Due to their poor cash flow, poor
financials, poor ratios, and recent change in leadership, they need a stable support base. This
stability and support from New Era adds an additional level of security for lenders if Star River
were to request additional sources of funds from outside financers.
Based on all of the above, Star River is growing at a rate they cannot meet, which is in align with
what the banker stated. Due to the declining market of CD-ROM’s, Star River should begin the
full transition into the DVD market or they will soon be out of business due to declining sales
revenue of CD-ROM’s. Firm restructuring is needed. Areas of concern are sales revenue, growth
and market penetration, inventory/supply chain, SG&A’s, production processes.
Sales revenues and growth should be a focus of Koh’s, since revenue is a driver of most
everything else. She needs to ensure Star River can stay at the projected 15% or greater. Should
they fall below that, they will face issues since sales growth drives most financial decisions.
Koh has taken on two additional capital expenditures, one for SGD $57.6m and one for
SGD $1.82m. Due to the increase in debt, Koh will need to focus strongly on controllable
spending, such as inventory, production costs and expenses, and SG&A’s. An audit of their
current inventory is needed to determine what is still usable with the DVD market. At which
time, whatever is not usable should either be resold or written off. A review of current supply
chain processes is required and a solution needs to be developed to reduce their inventory
holdings. Due to the transition into the DVD market, Koh will have to strategically plan the
purchase of new DVD inventory, and not create over-abundance, as in the past.
Tighter controls by management on SG&A’s and production will also help create greater net
income for Star River. It is recommended they also adopt moving to a Just in Time or Kaizen
type of production process.
Restructuring in these areas will produce greater revenues, lower expenses and greater
shareholder value, however they still have the issues of the large amount of debt they have
undertaken. It will take many years until Star River can become fully lucrative and not as
dependant on debt. In the meantime, they need additional financing to get them through the next
two years. If I were a conservative lending institution, I would not lend Star River the money.
However, if I were an institution that wagered in high-risk companies, then Star River is a good

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investment. They had the reputation in the past to get them through when others were failing,
therefore hedging on that and the restructuring of the firm, I would lend Star River the money.

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