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FOR BOARD OF DIRECTORS
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CRE have identified suitable outsourcing manufacturers CRE will consider adopting Google¶s operating system (OS) Android.CORPORATE FINANCE FIRST ASSIGNMENT To: Board of Directors Conch Republic From: Jay McCanless 1. The sale of our current PDA model in the market isexcellent due to its variety tropical colors. However as with any electronic item.0 Executive summary Our Personal digital assistant (PDA) is one of the major revenue producing items. According to Haskin. technology changes rapidly and our current PDA has limited features in comparisons with the competitors. David demand for smartphones is growing and is taking over the market share of traditional PDA. The capital requirement to develop this new smartphone is going to be quite significant and CRE has accepted the fact that financing of the new project would have to be made from existing cash resources and outside finance. CRE see the future potential growth in this new PDSA or smartphone. Assumptions Made CRE¶s reserves would only be able to provide 60% of the capital required Present manufacturing capacity will not be able to support the new manufacturing line. Conch Republic electronics (CRE) is considering the development of a more sophisticated PDA with additional features including cell phone capability and being able to run different forms of productivity software designed for business. 1 .
2. The new smartphone will have all the features of the existing PDA while incorporating newer features such as cell phone capability and the ability to run different forms of productivity software desired by business and other users. 2 . Our PDA is at the maturity stage of the Product Life cycle and soon will be at the decline stage. CRE could increase sales by targeting different market segments such as businessmen and college students who will find the productivity software attractiveness. our current PDA has limited features in comparison with our competitors¶. the management is planning to develop a more sophisticated PDSA or smartphone. The capital requirement to develop this new PDA or smartphone is will be significant. Could the manufacturing be out sourced to an electronic manufacturer with the expertise in this area or to use our existing manufacturing capability to do so? The key issues facing management for this project can be summarized as the following:y y y y The Corporate financing risks involved The rate of return expected for the project The rate of return expected by outside investors The decision making complexities for a project of this nature. The management also needs to consider the most appropriate business model to apply.0 Introduction The Personal digital assistant (PDA) is currently one of CRE¶s major revenue producing items. With the rapid changes of technology. Management has accepted the fact that the financing of this new project would have to be made from existing cash resources and outside finance. In order to remain relevant and increased market share.
Android etc. CRE would also need to develop new OS or consider licensing rights to use Microsoftµs Windows or Goggle¶s Android OS. as it were. CRE will need to use faster processor in order to run the various business applications and have larger built in memory for storage space. But what are the basic components and technologies that help it work its magic? What's under the hood.0 Components In A Smartphone ³We're in love with all of the things our phones can do. Likewise. touch screen durable glass variety Processor Built in memory and slots for memory cards Microchips to run the various applications such as image sensor for camera Operating System (OS) such as Windows Mobile. III.3. V. of the typical smartphone?´ (How Stuff Works) I. IV. II. Phone Display. 3 . The present components used in our current PDA need to be upgraded in order to produce the smartphones.
2 Option 2: Outsourcing The Manufacturing of the Smartphone CRE could also outsource the manufacturing of the smartphone. economic and strategic connotations. The above are two business models which CRE is considering and the Board would need to select. It is not unusual for companies to outsource regularly. Outsourcing is contracting with another company or person to do a particular job or function for you. 4. Capacity has technological. CRE also need to evaluate whether the present premise is suitable to accommodate the extra job functions.CRE would only need to pay the outsourced manufacturer the agreed price for the smartphone.0 Business Models Consideration 4.1 Option 1: Using Existing Manufacturing Capability CRE could consider using the existing manufacturing capability to manufacture the new smartphone. When manufacturing organizations are making key decisions regarding manufacturing facilities the important aspect that comes to mind is capacity. Outsourcing can help companies be more efficient and cost effective. workers¶ salaries and benefits and etc. CRE will need capital investments to increase capacity and also to invest in technology to leap from PDA maker to a smart phone manufacturer. Apple is also outsourcing the manufacturing of its IPhone. 4 . It only involves variable cost.4. To a certain extent manufacturing capacity also decides the nature and purpose of a business unit. CRW do not need to worry fixed costs such as overheads. structural. Software engineers and relevant manpower need to be hired to get the job done.
a practice knowing as ³levering up. In Option1.0 Key Issues 5. CRE would also need to increase the manpower for the new production line. The use of retained earnings as opposed to new shares or debentures avoids issue costs. in line with realistic expectations. inviting them to subscribe cash for new shares in proportion to their existing holdings. Both of this would be able to provide about 60% of the required capital. CRE is aware that the company must restrict its self-financing through retained profits because shareholders should be paid a reasonable dividend. CRE could have a rights issue which provides a way of raising new share capital by means of an offer to existing shareholders. New machineries need to be purchased and would also require a large amount of capital. Drop in future dividend earnings will cause unhappiness for the shareholders. the loan may default and becomesnone performing loan (NPL).´ but each loan will be noted on the credit rating. Interest rate can fluctuate and the variations could be significant due to present economic climate.1 The Corporate Financing Risks Involved Managing risk is an important part of operating a business. CRE could look into its own existing resources and also retained earnings. CRE could use retained earnings to fund the investment. By taking the bank loan. For option 2. Total cost of production per unit may be higher but there is no extra cost involved. CRE will be exposed to interest rate movement risk.5. Corporate financial risk is any situation or scenario that may impede a company's ability to achieve its financial goals. CRE would need to invest on a new plant to start the new production line. In order to finance Option 1. Another alternative is for CRE to get financing from a bank. 5 . It might seem attractive to keep bringing on debt when the company needs money. it is straight forward as CRE would only pay for the number of units manufactured by the outsourced manufacturer as per contract agreement. The remaining 40% would need to be sourced through equity or debt. If not. CRE would also need to ensure that operating profit is adequate to service bank interest.
" For an investment to be worthwhile. the expected return on capital must be greater than the cost of capital.According to HTC. which is the premium for the expected risk. A company's securities typically include both debt and equity. Cost of equity = Risk free rate of return + Premium expected for risk Shareholders will demand higher return for high risked investment. There is a need to be innovative as the smartphone technology changes fast. To incorporate new features into the smartphone such as cell phone capability. a rate of return larger than the cost of capital is usually required. Annie).5. camera and ability to run different forms of productivity software will need high investment on research and development to develop new operation system (OS). Goldman assures that "the market cycle at some point will stop shortening because customers can't absorb new products so fast. in 2007. Technology is racing forward at such a fast pace that consumers are having trouble keeping up. If a project is of similar risk to a company's average business activities it is reasonable to use the company's average cost of capital as a basis for the evaluation. Now. However. 6 . the average shelf life for smartphones is about six to nine months. one must therefore calculate both the cost of debt and the cost of equity to determine a company's cost of capital. but it definitely will not go back to the way it was (Ferreira.2The Rate of Return Expected For The Project To manufacture a new PDSA or smartphone would involve a high investment cost. the average shelf life for smartphones was around three years. The cost of capital is the rate of return that capital could be expected to earn in an alternative investment of equivalent risk.
This type of joint venture helps smartphone manufacturers from spending extra cost to develop operating system while Google¶s Android will see a bigger demand. For an investment to be worthwhile. For example. the risk-adjusted return on capital that is. 7 . Devices must also meet this definition to be eligible to license Google's closed-source applications. Outside investors would also include joint ventures with other corporations. business contacts. Individuals. the return must be more than that. but the probabilities of those projections must be higher than the cost of capital. this investment is quite risky. incorporating not just the projected returns.3 The Rate of Return Expected By Outside Investors There are several different sources of outside investors. Google will earn extra revenue from advertisement and increased purchases via the Android Market which offers many software applications for the smartphones. the expected return on capital must be greater than the cost of capital. the ERR should be higher than a risk free investment such as fixed deposit (FD). Samsung and HTC have formed strategic alliances with Google. if the present FD rate is 3%. Capital used for funding a business should earn returns for the capital providers who risk their capital. CRE is considering a premium of 8% to 10%. including the Android Market. Outside investment can suit promising businesses that do not expect to produce a lot of spare cash in the short term but offer the potential of greater returns over the longer term. The premium expected depends on the risk of investment. where they produced smartphones using the Android operating system software owned by Google. business angelsinvestment funds and venture capitalists for larger investments. device manufacturers cannot use Google's Android trademark unless Google certifies that the device complies with their Compatibility Definition Document (CDD). to ensure that outside investors will consider investing in our venture.5. Outside investors would expect a higher premium for the risk they need to take. Even though the software is opensource. Expected Rate of Return (ERR) ERR = Risk free rate of return + Premium expected for risk To attract outside investors. In other words. As the smartphone technology changes fast.
CRE have done a feasible study and the present premise would not be able to run another production line for the new smartphone. Alternatively. CRE may lose sales and incur losses. Apple and Samsung¶s various lawsuits are clear examples on the risks of intellectual property infringement (Yang Jung). There are several potential problems that may arise from outsourcing manufacturing. To save further cost. CRE¶s management knows that we need to produce the new smartphones. The capital investment needed will be large and the management would need to consider financing the investment via equity or debt. There is minimal financial risk and CRE would not need to invest heavily on research and development (R&D) to manufacture the smartphones. CRE would also need to hire skillful workforce to run the operation. There is a possibility of these µtrade secrets¶ being leaked out to the competitors. CRE could also ensure the smartphones have an open operating system which could run on Windows Mobile or Google¶s Android operating system. machinery. CRE must ensure that the manufacturer be held liable and will compensate any losses due to delays or poor quality. equipment and also increase in workforce. HTC and LG are utilizing this system. Large manufacturers such as Samsung. CRE would not need to increase capacity such as investment on factory. CRE could also outsource the manufacturing like Apple on its I-phones. CRE would not need to raise extra capital and only pay for the units manufactured as per agreement with the manufacturer. Problem with quality control may arise as CRE would not be able to have control on the manufacturing plant. In event of delay in production. There is a need to build a new premise or lease it to have the capacity to produce the new smartphone. CRE would need share expertise with the manufacturer and incorporate certain technology and software from present PDA into the new smartphones. Current demand for smartphones have been increasing yearly and players like Apple. RIM and Samsung have a good head start in this segment. 8 . CRE could manufacture the smartphone which will allow the company to have full control on quality control as well as trade secret such as new software or technology.4 The Decision Making Complexities In order to maintain our market share and to grow the business.5.
Samsung and HTC. 9 . RIM. The manufacturer would be able to incorporate new hardware and also new features to compliment what is available on our current PDA and create a smartphone.5. Shin reported how even LG lost the smartphone race. we cannot predict the total success of the smartphone. CRE would need high capital injection in order to compete with the big players such as Apple. asKiju. CRE¶s shareholders must study the key issues and also take into consideration the complexities of making the decision. The change in smartphone technology is racing forward at such a fast pace that consumers are having trouble keeping up. where the manufacturing is outsourced to a manufacturer. Even after investing heavily on R&D and including extra hardware and features. Capital cost is minimized and CRE would have less exposure due to product failure. it will not be easy to make a decision.5 Recommendation Looking at the two business considerations. Big computer manufacturers such as Dell and Acer have also taken the plunge into the smartphone market. I would propose CRE to adopt option 2.
gov. Choose the right finance when starting up.com/2011/02/15/news/international/lg_smartphone_failure. What are the hardware components of smartphones? Available online at http://curiosity.2000033 (Accessed on 1/7/2011) 3. How LG lost the smartphone race. Yang Jung. 2011. Pearson Education Ltd. Available online at http://money. Available online at http://www.com/s/article/9004592/Another_nail_in_the_PDA_s_coffi n_?source=rss_topic15 (Accessed on 29/6/2011) 5.uk/bdotg/action/detail?type=RESOURCES&itemId=107 6795354 (Accessed on 29/6/2011) 2. 2011. Available online at http://www. Shin. Ferreira. Haskin. Get outside investors to help finance your business. Bloomberg news Jun 24. Gitman.discovery. Escalating Legal Dispute.com/news/2011-06-24/apple-files-patent-suit-againstsamsung-electronics-in-s-korea. Android OS changes smartphone life cycle.bloomberg. CNN February 15. Annie.cnn.computerworld.theusdvista.References 1. Available online at http://www. Principles of Managerial Finance 13th Edition.htm (Accessed on 2/7/2011) 6.com/question/hardware-components-ofsmartphones (Accessed on 28/6/2011) 7. The Vista February 16. 2011. Another nail in the PDA's coffin? Computerworld (30-10. Kiju. Apple Files Patent Suit Against Samsung in Seoul.fortune/i ndex.businesslink.2006) Available online at http://www.com/business/android-os-changessmartphone-life-cycle-1. How Stuff Works. Lawrence & Zutter.html (Accessed on 30/6/2011) 10 . Chad J. David. 4.