- Pages: 4
- Word count: 983
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The analysis will evaluate options available to Guillermo Furniture Store to remain profitable. The analysis will review three projects the first being the current method of business the second project under consideration is a change to a high tech performance company or the final project under review is a brokerage company.
New competition entering the market requires existing companies to evaluate the current business operations Guillermo Furniture Store Inc., once cornered the market for hand crafted furniture and the presence of new competition threatens the financial stability and growth of the company. The company’s options are to remain independent and continue business as usual, invest in hi-tech machinery to reduce labor costs and reduce the price of the products or become a distributor of the product otherwise known as a broker. Guillermo must review the competition, referred to by Emery et al as the “Behavioral Principle” in determining the best financial outcome for his business (Emery, D.R, Finnerty, J.D. & Stowe, J.D., 2007). The behavior principle will assist him in weighing the benefits and drawbacks of each method of business. Analysis of information begins with the review of the three options available, beginning with current operations. Current
Continuing to produce furniture as normal has the benefit of familiarity. Guillermo Furniture Inc. employees know how to make furniture by hand, the company may have a higher risk of failure with more modern equipment. The company could save money and cut costs by reducing employee pay due to skill level. In comparison to the competition continuing to operate as usual poses the risk of becoming obsolete. As competitors with high-tech equipment sell similar products produced quickly at lower prices, Guillermo risks losing business and closing the doors to a family company. Hi-Tech
Changing the Guillermo Furniture Store business to high-tech production has the benefit of increasing production by 50% while eliminating most direct labor costs. Another benefit that is overlooked in the NPV analysis is Guillermo Furniture Store Inc., will own a large factory with high-tech machinery, the machinery will be listed as an expense that depreciates, and will reduce the NPV of the project, to offset the negative effect on NPV be aware that the equipment has value and can be sold later. The cost of the new machinery is high and Guillermo would need to test the newly made furniture to check for popularity among his customers before changing the business entirely, if a test sampling is not completed and customer do not like the machine crafted furniture the company will have made a costly error. And Guillermo will need to adjust for the expected sell at a 10% discount due to increased supply. Guillermo has a third choice available to remain competitive with the competition; the company could transition to a broker of furniture. Broker
The benefit to Guillermo will be the reduction of paying as many employees to manufacture furniture by hand. Expenses such as insurance, utilities, benefits, basically any overhead expense will go down significantly. The company’s risks are the same as the transition to high-tech equipment. Direct costs will increase for mid-grade unit production with shipping and tariffs. Calculation of WACC
The WACC is larger for owning a high-tech company or becoming a broker for a high-tech company as opposed to business as usual, because both options require a large increase of equity to finance the expensive machinery. These options raise the risk with the increase in the cost of capital but also provide the opportunity for higher returns than the current business model. It is important to remember that “misusing a firm’s WACC to evaluate new projects could lead a firm with low operating risk, such as a utility, to take on high-risk projects, such as drilling and exploratory oil wells” (Emery, D.R., Finnerty, J.D. & Stowe, J.D., p.200, 2007). Risk can be reduced by funding the new business model with cash instead of equity. To find the NPV of each method, take the total cash flow for that method and discount by the WACC we just found for that particular method. Sensitivity Analysis
The effect of a 50% decrease in production on NPV for each method produces dramatic results: the Current method moves from positive to negative, the High-Tech method is reduced by 75% to fewer than 100,000, and the Broker method is reduced by 90% to fewer than 80,000. The biggest change occurred with the High-Tech model, the Current method shows a reversal from a positive NPV to a negative one. The negative NPV indicates that the current business model used is weak and will fail if continued. The other options available high-tech or broker will not produce profits that Guillermo Furniture Store Inc. has seen in the past but the company would still turn a profit. Justification of Recommendation
Guillermo can use financial information to make profitable decisions, change operations based on decisions made to create a new operating structure. Profitability, value, earnings, assets, liabilities and dividends are all used to monitor the company and review the competition. The hi-tech option allows Guillermo the opportunity to exceed expectations of business partners, employees, and the customer alike. These firms often exceed the expectations of customers, business partners and employees. The high-tech option will produce increased efficiency and productivity and a higher return. The value of the company will increase and changes the company from local competition to international. The initial investment is large but reduction in variable costs is expected with a slight increase in fixed costs. To remain an independent business operating within the family the hi-tech option is the best model for Guillermo to venture into.
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. (2009). Guillermo Furniture Store Scenario. FIN 571-Finance Course Website: https://ecampus.phoenix.edu