Guillermo Furniture Store Analysis
FIN 571 Corporate Finance
Guillermo??™s Furniture Store experienced some challenging decision-making that deals with finance and the operating future because the foreign competitor engaged with the furniture business in Sonora, Mexico. The challenge decision that Guillermo need to make is to whether do business with large organization or remain as an independent company and continue to stay within the competitive market. Guillermo has to make the best decision for the business and make sure every factor of concern has been addressed. One of the factors is to make sure the business can afford a merge financially and /or continue to compete with other companies. Guillermo should also consider if purchasing enhanced machine equipments that would help promote the business as well as looking at the prices. Third, Guillermo should consider another alternative such as changing business plan from manufacturing to distributing. This alternative plan will allow Guillermo to continue to manufacture products while distributing products for Norwegian company.
Guillermo is facing two critical issues he did not have to be face with before another company joined the furniture market. The hi-tech machinery producing furniture at low costs is a downfall for Guillermo. Guillermo??™s furniture store does not use hi-tech machinery but will probably have to look into options. This option must be a low cost-effective way in producing his furniture. The solution would be to keep the profits at the same levels, but Guillermo must find those ways on how this going to happen.
Another issue that Guillermo is facing is the rising cost of labor. The population in Sonora, Mexico is increasing that is impacted by the labor in the area. Guillermo should consider his ability to compete with current operating and pricing structures, whether if the hi-tech machinery is purchased or not or perhaps purchasing similar equipment. If Guillermo purchase similar machinery equipment, this would allow him to reduce prices even if he partner with Norwegian company.
In generating alternatives for Guillermo, first the budget must be reviewed by analysis and making reasonable decisions. ???The income information on the Guillermo Furniture Budget displays revenue and cost between Guillermo??™s current operational practices,??? (University of Phoenix, 2010, p.1). Some of the key information in this income statement is the difference between using hi-tech machinery or not and a relationship with Norwegian and Guillermo??™s company that could be used for the manufacturing. In reviewing the net income of all three scenarios it shows purchasing new technology would to compete with large companies would gain profit. Next is the relationship with Norwegian followed by Guillermo??™s current operational practice.
If Guillermo decide to continue his operation under his current plan he will continue to see his cost increase and his profits will decrease. It is very difficult to predict any future sales at this time and being remindful of the factors that can hinder the furniture market. The labor cost is rising and Guillermo??™s time in the furniture market is limited now. This decision would be a risky one because Guillermo will be forced to layoff employees and sales will decrease.
If Guillermo decide to purchase a hi-tech machine similar to something his competitors are using, Guillermo??™s cost may have to be reasonable to purchase. This cost will probably help Guillermo in the long run if his cost is lowered to produce the furniture. A risk in doing this is that Guillermo sales will not increase by much. Another risk is that he would probably lose his cliental that he build up in Sonora, Mexico. This decision will force Guillermo to hire additional employees and this could also be a downfall especially employees have to be trained on the new machinery and the different skill sets.
The final alternative is to enter into a broker-style relationship with a Norwegian furniture company. The Norwegian furniture company produces high quality furniture at a low cost like Guillermo??™s. With this role, Guillermo will be the sole distributing company versus being the manufacturing company. This particular alternative will allow Guillermo to retain all his employees but will probably have to change the job descriptions and roles. Another gain of this alternative would be that Guillermo will limiting his liability because no major change to expenses on hi-tech machinery.
Weighted Average Cost Capital
According to Emery, Finnerty, & Stowe (2010), ???Weighted Average Cost of Capital (WACC) can be expressed as the weighted average of the required return for equity and required return for debt,??? (Ch.8, p.198). WACC is the rate of return that is required to keep the company??™s value consistent. If the company??™s value is expected to increase, the required rate of return must exceed WACC. If the rate of return is less than WACC the company value will drop. Guillermo??™s WACC for the current operating structure is 5.74%. Hi-tech WACC is 10.47% and broker-style relationship with Norwegian company is 10.63%. One valuation technique that can be used for Guillermo??™s scenarios are the discount cash flow. This technique would help Guillermo??™s value on its future cash flows using each scenario.
Net Present Value
The net present value (NPV) for Guillermo??™s Furniture Store under the current operational structure is $47,955.59 for 2010. The hi-tech scenario, the NPV is $173,422.92 and broker-style relationship, NPV is $83,244.57. These numbers shows hi-tech as the highest NPV versus broker scenario is the negative NPV. The current operational structure of Guillermo??™s has a positive NPV.
To perform a sensitivity analysis of each scenario available to Guillermo, production was reduced by 50%. By reducing the production values, the NPV for the current operational structure remained positive at $725.38 that is smaller than original NPV of $47,955.59. The production rates results for hi-tech solution from $173,422.92 to $150,849.03. Broker-style solution is from $83,244.57 to $269,691.58. The current operational structure still remains positive NPV in reduction of sales. The current operational structure produces furniture as furniture was needed and keeps overhead at a minimum.
Guillermo??™s decision to improve future financial obligation would better the business strategy. Guillermo??™s should consider purchasing new equipment and deciding to deal with competing with large companies. Retaining the current operational structure may decrease profits on a smaller dimension. The broker-style relationship of Guillermo??™s store changing from manufacturing shop to more of a distribution center. The broker-style relationship had a financial risk as demonstrated by the calculated NPV. The hi-tech scenario offers the most risk out of the three scenarios. When the production and sales are high, the NPV is positive. The least risky of the scenario is the current scenario.
Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management (3rd ed.). Upper Saddle River, NJ: Pearson Prentice Hall.
University of Phoenix. (2010). Guillermos Furniture Store Scenario. Retrieved from University of Phoenix, FIN571 website.