Star Appliances Harvard Case Solution & Analysis

Star Appliances Case Solution 

Description:

Ken McDonald founded Star Appliance Company in the year 1922. The basic production line of Star Appliance Company was to manufacture electric stoves and ovens. The Star Appliance Company earned a brand name with the increase in demand in electric stoves and ovens and as a result, it became the market leader during 1920s. However, Star Appliance suffered a lot during the period between World War I and World War II.

During these wars, the companyreduced its operations to survive during the depression as well as itfocused on selling tothe premiummarketwhichwas lessaffected by the Wars. Many firms went bankrupt during the period whereas, at the end of the World War II, Star Appliance maintained itselfas a strong company.Moreover,Ken McDonaldhadpriority of minimizing debt financing as that was the reason of survival of the company during the great depression. He also soldthe common stock of the company to finance the company’s operations rather borrowing loan.

Star Appliance added refrigerators and gas ranges to its product line. During those three decades, the main focus of the company was still the premium market. The founder of Star Appliance, Ken McDonald,retired in the 1963 from his position in the management. During his tenure, the company was perceived as a premium goods company, which allowed the company to quote a price higher than its competitors. The premium image of Star Appliance benefited the company in equity financing from its high margin profits.Moreover, Star Appliance often sold its equity to finance its operation. As a result, in 1978 the stock was widely detained by the outside investors. The issues arose with the decrease in growth in product lines which forced the management to introduce new product line.

Evaluation of Investment:

With the emerging demand of the market the management was forced to expand its operations by introducing a new product line. The problems faced by the industry led to the downfall in the stock price of Star Appliance. The management of the firm believed that the stock price could be increased by the introduction of new products in the market.

The management also expected that the introduction of new products would enable the company to continuously increase its price to earnings ratio and bring it back to its normal state. The management proposed three new product lines, all of which were focused on expanding its kitchenware appliances or products related to it. Dishwasher, food disposal and trash compactor were the products proposed by the management as they believed that the products would increase its sales as well as they were also appropriate for the expansion in kitchenware products.

Star Appliance strongly believed in analyzing the projects in term of their future worth and profitability. The hurdle rate of company is 10% whichis compared to the project’s Internal Rate of Return in order to evaluate the profitability of the project. Due to the company’sdependency on equity financing, the project with highest internal rate of Return will be implemented first and others will be postponed for abetter project.

The conflict arose when no particular product was used to measure the hurdle rate of Star Appliance. Foster believed that the company had a much lower hurdle rate than 10%. The figures in exhibit 5 reveal that the projects of Star Appliance are riskier than the treasury bills. The projects implemented by the firm have higher return but with more risk associated with them.

Methodology:

WACC

The WACC is used to evaluate the company’s equity and the debt ratios are delicately managed. The increase in WACC proposed an increase in risk associated with the project which simultaneously reduced its valuation. The companyuses WACC as a tool to determine the value or rate of return requiredby the company to pay back its equity and debt financers.

The company has WACC of 10.30 %, which illustrates its influence in satisfying the debt and equity holders with a return expected to be the value of WACC..............

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