"Capital Budgeting is the process of determining whether or not projects are worthwhile. Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow and payback period" (Investopedia, Inc.). Capital Budgeting is an important part of corporations and small businesses because they aid in making key business decisions. Capital Budgeting can be looked upon as an appraisal of business investments. Lester Electronic Inc., has decided to undergo an acquisition of Shang-Wa electronics in order maximize its shareholders wealth. The success of LEI's investment decision is dependent upon their ability to define and mitigate possible financial risks involved with the decision.
The possible financial risks involved with acquiring Shang-Wa include asset quality problems, where one company may have a weak loan portfolio which can drain the financial health of the acquiring company. Accounting problems of the target company also present possible risks because the acquiring company may incur charges associated with restructuring and experience declines in intangible assets. Compliance issues may also present a financial risk to the acquiring company. If the target company is violation of tax laws or undergoing some for of litigation, the acquiring company could acquire legal fees and fines, although these issues may have emerged pre-acquisition. A decrease in the stock prices of the acquiring company is another possible risk for Lester Electronics. Mark Thornton of the Quarterly Journal of Austrian Economics reported, "M&A can also affect demand if current shareholders find that the newly formed company is no longer appropriate for their portfolios. A decrease in stock price for acquisition firms is, therefore, not irrational nor completely unexpected." Mr. Thornton also adds that, "The largest companies are precisely the ones that are allowed the fewest opportunities to enhance shareholder value...
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