Straightline Medical produces linear bearings that are essential components of t
ID: 435215 • Letter: S
Question
Straightline Medical produces linear bearings that are essential components of the rotary drives within a variety of medical devices and machines. Production of linear bearings requires high levels of repeatable precision. Straightline is considering the purchase of a Fanuq Robodrill in conjunction with a Robotic operator. The Fanuq Robodrill is a fully-fledged compact Computer Numerical Control (CNC) milling, tapping, and drilling center that delivers unrivalled quality and precision (Fanuc Corporation, 2016; Thomas Publishing Company, 2016). Proven to be extremely robust and reliable, it offers the shortest cycle times for most milling and drilling tasks. Together with a robotic operator, this device will be integrated into existing CNC systems, which offer component designs for the larger-scale manufacturing processes. CNC results in highly automated manufacturing components which use computer-aided design (CAD) and computer-aided manufacturing (CAM) programs. The programs produce a computer file that is interpreted to extract the commands needed to operate a particular machine by use of a post processor, and then loaded into the CNC machines for production. Since any particular component might require the use of a number of different tools – drills, saws, etc., – the machines are often combined into a single ‘cell’ operated by an external controller and human or robotic operators that move the component from machine to machine. The series of steps needed to produce any part is highly automated, and produces a part that closely matches the original CAD design. ReferencesFanuc Corporation.
Assume that you are finance director at Straightline Medical. Straightline's director of operations is considering purchasing a Fanuq Robodrill and robotic operator for integration into our assembly lines. This will be used in medical machining, which is CNC machining related to surgical implants, orthotic devices and medical instruments, which we manufacture. Because these new medical devices are developed quickly and refined through many iterations, efficient small-batch machining is almost exclusively outsourced, currently. The director of operations believes that the incorporation of this technology ‘in-house’ will make Straightline substantially more competitive, by reducing production costs – raising the profit margin on our devices. Nevertheless, as finance director, you are aware that the market for both debt and equity instruments may not be favorable if the firm should need substantial external financing, as it seeks to acquire the drill and robotic operator. With this in mind, you intend to analyze features of debt and equity instruments as these will impact the firm’s financing decision as the firm moves forward with adoption of this costly technology, and present your evaluation of financial risks to a group of directors including the firm’s director of operations. You plan to outline the consequences that technology acquisition could have, in the event that inflation drives interest rates up over the period in which the firm will be obtaining needed financing, and in the event that revenues fluctuate or fall below expectations. While you understand that the project will not be considered unless it yields positive net present value to the firm, you are concerned about meeting repayment obligations, and you are concerned that the cost of financing may exceed original estimates. Given that the degree of external financing needed is substantial, you feel that management should be aware of these possibilities.
QUESTION:
Assume that you are addressing a group of directors including the firm’s director of operations. Speaking as the finance director of Straightline Medical, plan to evaluate alternative methods of financing, including debt and equity instruments, on the purchase of a Robodrill in conjunction with a Robotic operator for expansion of production of components of the rotary drives within a variety of our medical devices and machines. Also, plan to provide a recommendation for the best financial tool to facilitate adoption of this technology:
1. While minimizing the impact of this major technology acquisition financing decisions on other areas of operations, through the diversion of existing resources, and considering variability in revenues.
2. In light of effect of inflation on financing costs when choosing among financing strategies (stocks, bonds or loans), as you believe it will affect this decision.
Explanation / Answer
Capital structure indeed does facilitate to indicate how a firm by using different sources of funds eventually finances its overall business operations and growth. Debt comes in the form of bond issues or long-term notes payable whereas equity is classified as common stock or retained earnings. Furthermore short-term debt such as working capital requirements is also considered to be part of capital structure.
Capital structure can be a combination of firm's long and short-term debt and equity funds. Market research studies while analyzing capital structure generally refers to firm's debt-to-equity (D/E) ratio which indeed effectively facilitates to provide an insight on company’s exposure to risky elements. Furthermore a company which is usually heavily financed by debt has more hostile capital structure and thus eventually confronts great risk to investors.
Debt is indeed regarded as one of the major source through which companies can raise funds in the capital markets. Furthermore firms can raise debt funds because it has tax benefits wherein the interest payments are allowed as tax deductible expense. Furthermore unlike equity debt allows company to retain the ownership rights.
Equity is indeed regarded to be more expensive than debt especially when interest rates are low. However unlike debt equity need not be paid back if earnings decline. Furthermore equity does facilitate to represent a claim on the future earnings of the company as a part owner.
Companies that use more debt than equity to finance assets have a high leverage ratio and hostile capital structure. A company that pays for assets with more equity than debt has a low leverage ratio and a conservative capital structure. However high leverage ratio and aggressive capital structure eventually can lead to high growth rates whereas conventional capital structure can guide to lower growth rates.
Thus it is indeed regarded to be the most crucial and significant objective of business administrators to effectively recognize and acknowledge the optimal mix of debt and equity eventually also referred as optimal capital structure to effectively finance its business operational related activities.