STATEMENT OF THE PROBLEM
Star River Electronics Ltd. is a large manufacturer and supplier of CD-ROMS. It was founded as a joint venture between New Era Partners and Starlight Electronics Ltd. It has enjoyed a great deal of success in the past decade, due in large part to their excellent reputation.
Star River does need to address several issues with the recent resignation of their former CEO. Digital Video Disks are expected to cut into the CD-ROM market in the very near future, and with only 5% of their sales coming from this area, Star River needs capital expenditures to increase their capacity in this sector. To finance this expenditure, they can use either debt or equity. Also, a new packaging machine which would cut down on labor and overhead costs has been proposed, and Star River needs to know whether to approve the purchase now, or wait three years, where new equipment would have to be purchased to handle the projected growth rates.
Finally, a weighted average cost of capital needs to be estimated for the firm, which will help to answer this question of whether to wait or buy this equipment at the present time.
RELEVENT FACTS AND ASSUMPTIONS
DVDs have 14% more storage capacity than CD-ROMs
1999: CD-ROMs accounted for 93% of sales
o Estimated to decrease to 41%
2001: DVDs accounted for less than 5% of sales
o Estimated to increase to 59%
The new DVD manufacturing equipment will cost SGD54.6 million
o The new equipment costs will be paid throughout the next two years.
o The new equipment will be depreciated over seven years.
o Assume that funding for the new equipment will be through debt
Interest expense is weighted for short-term debt and long-term debt: 6.53%
The new packaging machine will cost SGD1.82 million.