Case analysis #2

DYNATRONICS, INC.

1. 1. Introduction
Dynatronics is a company with almost ten years of experience in designing digital systems and producing several
lines of other related items. The company was founded in 1979 by three electrical engineers, later 2 managers have
been added as stockholders and currently these five people own entire equity of the company in approximately
equal blocks.

Initially the company started with a single product offering, later as the company expanded, several proprietary
items were added as components of previously provided digital systems, then designing special-purpose systems
were also added and finally we received a company having a wide range of digital products and service offerings.
Though, the majority of the profit that Dynatronics, Inc. generated came from the sale of proprietary products that
were quite easy to imitate, regardless of having the patent rights, competitors could freely design products that
could perform the same functions and significantly affect Dynatronics’s sales in turn. This is where the roots of the
company’s existing financial problems take place.

As a response, company invested much in Research and Development works in order to impelement new products
and offerings to the extremly competetive market . Nevertheless, in April 1989 the company faced serious financial
problems when reviewing the introduction of new product line. The company`s financing opportunities were
restricted by its current financial position.

Therefore Ms. Liz Kraft, CFO at Dynatronics believed that any major investment would create further financing
pressure. Thus she has to decide to discuss with managers all the problems and highlighte the key issues of the
company such as:
 inventory management system and policy
 introduction of new products and external financing needed for growth
 how varying assumptions can affect the  value of a project itself.

From our point of view Purpose of the case is to analyse the current situation of the company, identify main
problems the company faced, provide possible alternatives and select best solutions for improving the businness
performance in future, that is discussed below in this document.
2. 2. Current analysis of the Industry and Company

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Products:
Company  started with producing of digital systems with several lines of proprietary items sold as components and
principally great part of their profit came from the sale of these proprietary products. After succses in this field, they
expanded the business to variety of special-purpose systems that applied digital techniques to computing,
information handling, control tasks and data processing as theincreasing of customer demand, It acounted
approximatle1/4 of the companies sales. Additional profit had been gained from the provision of providing
engenering services to these systems.

Locations:
Over the years continuing expansion had led to a number of changes in Dynatronics’s internal organization. Sales
outlets had been established in Silicon Valley. In 1987, a small plant had been constructed there for the design and
production of systems for the aerospace industry. Earlier, production of proprietary products had been shifted from
Burlington to a wholly owned subsidiary in Puerto Rico, largely because of the availability in that area of a low-wage
labor force. Production operations at the subsidiary consisted almost entirely of assembling and packaging modules
and allied components. Other managerial offices remained at the original site in Burlington

Competition:
Dynatronics proprietary products were subject to a high rate of competition on the markete\ even though they were
protected by patents. Typically, the company's new products achieved about 75% of their highest sales level in their
first year. Peak volumes were reached and maintained in the 2-3 years an by the 6-7 years they were decreased
much. This six-to-seven year cycle had been cut short by competitive developments for about 20% of the new
products that the company had introduced during the past ten years, and on those occasions Dynatronics had been
forced to absorb substantial inventory write-offs.

Currentrly company evaluated most imprtant competitors finantiatial data for the period 1986-1989, that showed
that Dynatronics has the highest return on equity among the competitor in 1988 and It increased annually:
ROE
Company
1986 1987 1988
AMP Inc 14.5% 18.5% 19.5%
Analog Devices, Inc 8.7% 6.5% 11.1%
Dyntech Corp 18.8% 16.1% 15%
Dyatronics Inc. 7% 13% 24%

Strategy:
Company aggressively started to increase R&D expenditures to improve existing product lines and add new ones
with major concentration on product quality. These trials have led to increased demand in net sales, sales almost
tripled from 1986 to 1988 and correspondingly, company tripled its investments in operating assets, but these
investments were mainly financed with short-term loans obtained from a bank.

Inventory policy:
Some problems seemed in balancing raw material stocks and finished goods management. System dependended on quarterly sales
forecasts and the problem was inaccuracy of such estimates. Lead time required by the purchasing department and limited
interchangeability of parts among product lines combined to fix the required total at roughly a four-weeks' supply level and the

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 company was currently operating with lower finished-goods stocks (only for 2 weeks). During preceding months finished-goods
inventory had been deliberately reduced in relation to sales as other cash requirements had mounted. Continual curtailment of
investment in finished-goods inventory was likely to be costly in terms of lost sales and competitive position, but lacking other
immediate sources of funds, but currently it was only way for the company to avoid an acute cash emergency.

Current finantial position and forecast for year-end 1989 :

A) The growth prospects assumed;
 Sales: $34 million
 Cost of good sold: $20,74 million
 Receivables: 22%
The bank would lend up 90% of the account receivables balances outstanding.The interest rate charged rises to be
15.5%

B) The introduction of new product line assumed contribute to sales:

 $5 million in 1990 and $6.5 million in 1991
 $250.000 million (specialize equipment)
 $90,000 (budget allocation

C) External financing:
 Bank loan
 Issue up to 400,000 shares new common stock ($5 per share from $6.5 after costs andexpenses)
D) Inventory investment:
 Frequent delivery delays with five possibility inventories policies

3. 3. Definition of key problems

As mentioned above two key problems can be seen in the presented case. First is about which project to finance in
near future, note that the company has inventory management problems as well (due to the increased cash
requirements, company was forced to economize cash on having relatively small number of finished goods in
inventory and lost many consumers due to stock-outs in turn). Therefore, company has got several alternatives to
choose from: 1. finance investment in new business line and apply current inventory policy. 2. Finance investment
in new business line and apply one of the possible inventory policies from A,B,C,D,E alternatives. 3. Not finance
investment in new business line and apply current inventory policy. 4. Not finance investment in new business line
and choose one of the possible inventory policies from A,B,C,D,E alternatives. Detailed calculations to evaluate
each of these alternatives, their NPV-s and related EPS are provided in Excel sheets.

Second problem is to decide which sources of finance to use: One alternative is to obtain a credit from a bank as
previously, but the interest rate charged increases and obtaining credit becomes more expensive for the company.
Another source is to go on IPO and issue 400,000 additional shares but it is also quite expensive, since from the
offering price of $6.50 per share, Dynatronics receives about $ 5 net per share. Last alternative is to use internal
financing, namely continue re-investing of earnings in business without any payment of dividends. Our view about
which alternative would be best for the company to choose, will be discussed in detail below.

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 4. Possible Alternatives and their Evaluation
According to the finantial position of the company and evaluaating current and prospected growth possibilies, we
have identifiied 2 main alternatives for the future perfomrmance of the company:
1. Invetsment in New product line
2. Change of inventory policy
We hav ecombined all possible combinations of this alternatives and got 12 main directions in which the company
have movoe on. Detailed calculatons and finantial statemnts and rations for all these scenarions are provided in
attached Excel sheet (see encl. file). Based on calculations we have also determined required external finances for all
of them:
External Financing
# Alterntives
required
1 No Invest New Product Line & Inventory Policy AS IS $ 2093
2 No Invest New Product Line & Inventory Policy A $ 2285
3 No Invest New Product Line & Inventory Policy B $ 2626
4 No Invest New Product Line & Inventory Policy C $ 3081
5 No Invest New Product Line & Inventory Policy D $ 3649
6 No Invest New Product Line & Inventory Policy E $ 4161

7  Invest New Product Line & Inventory Policy AS IS $ 2293
8  Invest New Product Line & Inventory Policy A $ 2485
9  Invest New Product Line & Inventory Policy B $ 2826
10  Invest New Product Line & Inventory Policy C $ 3281
11 Invest New Product Line & Inventory Policy D $ 3849
12  Invest New Product Line & Inventory Policy E $ 4 361

4. 5. Conclusion - Recommendations for problem solving

he recommendations that Ms. Kraft should be given to the shareholders are:

1. Investment to the new product line for year 1989 – 1991.

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 2. Choose the inventory policy- E as It has the highest NPV with the highest external financing
required.
3. Apply both of external financing required with the lowest WACC and the highest marketvalue. The
composition of debt from the bank loan is 58%, and equity through IPO is 42%. In order  to fit with
the external finance required allocation ($4361), the composition of the maximumexactly amount are:
Equity (42%) : $1,832,000 (with 5$ price per common stock) Debt (58%) : $2,529,0004.
 
To apply the IPO, the company has to change the no dividend policy. Otherwise it will not getthe highest
market value.

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