Analysis GFS 1 Running Header: GUILLERMO FURNITURE STORE ANALYSIS
Guillermo Furniture Store Analysis Corey A. Moore FIN/571 William Rainwater
GFS Analysis 2 Abstract Guillermo Furniture (GF), owned by Guillermo Navallez, had been a very successful furniture manufacturer in Sonora, Mexico for many years. GF produced a variety of tables, chairs, and handcrafted products. Business was good until two competing forces combined, resulting in less sales. An overseas competitor entered the market using a high-tech approach and the local consumers became aware of a large retailer nearby, both of which provided rock-bottom prices. As a result, GF began to see a substantial decrease in profits economic costs continued to increase. The purpose of this paper is to present the analysis of different alternatives available to Guillermo Furniture, including sensitivity analysis, and to define alternative analysis. Given this information, topics of discussion are the optimal WACC and the use of multiple valuation techniques in reducing risks, as well as calculating the NPV of future cash flows for each of the alternatives discussed. To analyze his options, Guillermo researched the competition to learn how they were adapting to this change. In doing so, he concluded he had the following choices: (1) merge with or be acquired by a larger organization (2) convert to the high-tech solution used by the overseas competitor (3) coordinate his existing network and become a distributor for yet another competitor while marketing his patented process for coating furniture. To determine the best option, Guillermo will use alternative analysis, which is the evaluation of different choices available for achieving an objective (BusinessDictionary.com, 2010). For his intended purposes, Guillermo will use the Payback Made Simple, NPV, IRR, and Payback Discounted.
GFS Analysis 3 Payback Made Simple The payback period is the expected number of years required to recover the original investment (Emery, 2007). If Guillermo invested $300 million in one of its projects, he should be able to receive back the original money invested. For example, Guillermo's cumulative cash flow is at t = 0, just the initial cost of -$300,000. In the first year the cumulative cash flow is the previous cumulative of $300, 000 plus the first year for the cash flow of $500: -$300,000 + $42,573=-$257,427. In comparison the cumulative for the second year is the previous cumulative of -$257,427 plus the inflow of cash from the second year of $42,573, resulting in -$214,854. Therefore, the calculations of payback occurred during the third year. If the $40,584 of inflows comes in evenly during the third year, then the exact payback period can be found as follows: Applying the same procedure to Project High-Tech and Project Broker, the payback periods are approximately one and one-half years and almost six years respectively. As the payback period decreases, the quality of the investment increases. Therefore, Project High-Tech would be acceptable, but Project Current would not. Assuming the projects were mutually exclusive, meaning if one project is taken on, the other must be rejected (Emery, 2007). High-tech would rank the highest because it has the shortest payback. Net Present Value When making capital budgeting decisions, Net Present Value (NPV) is one of the mostused techniques. It relies on the Discounted Cash Flow (DCF), which is the technique used to find the value of the project in regard to the cash flow throughout the life of the project. Initial investments and expenditures, such as purchasing equipment or building
GFS Analysis 4 factories are negative cash flows because the investor's cash balance decreases with the investment. Although the cash flow out is negative for these three Projects, it can remain uneven in other Projects (Emery, 2007). When a project results in a positive NPV, meaning the net cash in investments increases, the wealth of the stockholders increases. In reference to the three Projects, shareholders' wealth would increase by $955,065 with Project Current and by $27,014 with Project High-Tech, but it would decrease by $26,755 with Project Broker. Therefore, taking on Project High-Tech is an easy decision because it showed the highest increase in shareholders' wealth. When determining the value of a Project, there exists a direct relationship between NPV and Economic ValueAdded (EVA). Therefore, if a Project has a positive NPV, either its EVA and Market Value Added (MVA) or the excess of the firm's market (book value) will remain positive (Fabuzzi, 2003). This technique would likely be used by the managers in Project Current. Internal Rate of Return The Internal Rate of Return (IRR) is similar to calculating the bond yield to its maturity. It is the discount rate that equals the present value of the projects expected cash inflows to the present value of the project's outflows. Factors to consider when using the IRR technique are that the cost of capital is becomes less and stockholders are penalized. This will method determine Project High-Tech to be the most valuable to Guillermo Furniture because the IRR for Project Current is 6.9%, 64.7% for Project High-Tech, and 11% for Project Broker.
GFS Analysis 5 Discounted Payback Period The Discounted Payback Period is the number of years required to recover the investment from discounted net cash flows generated from the Project (Emery, 2007). This technique takes into consideration the time value of money. According to the values of discounted cash flows, the Discounted Payback Period for Project Current is fewer than 10 years, compared to about one and one-half and more than eight for Project HighTech and Project Broker. This indicates Project High-Tech to be the most valuable. Unfortunately, all of these methods have disadvantages. Both the Payback Made Simple and Discounted Payback Method ignore cash paid or received after the period of the Project. This would occur, for example, if Project High-Tech had an additional cash flow in the fifth year. Realistically, more cash flows received after the payback period would be more valuable than no cash flow, yet the Payback Made Simple and Discounted Payback Methods appear to be worse. Hence, a shorter payback period (with other items held constant), results in greater Project liquidity. Because cash flows expected in the distant future are generally riskier than near-term cash flows, the payback is often used as an indicator of a project's risk because the longer the payback period, the higher the associated risk (Emery, 2007). A disadvantage of the Discounted Cash Flow method is that it doesn't consider the cash flow generated by the company after the payback period. As a result, the payback period for a Project with high cash flow is less valuable than a Project with no cash flow after the payback period. The analysis reveals several variables to consider when determining which one of the possible alternatives will be valuable in the success of Guillermo Furniture as it faces stiff competition from both internal and external forces.
GFS Analysis 6 One variable to consider is Guillermo's financial records, which indicate that total current assets consistently have and remained stable, total current liabilities have increased, and liabilities and equity have remained flat. This is a good indication partnering with a foreign competitor would increase Guillermo Furniture Store's. Assuming direct labor increased from $15 to $40, it becomes necessary to explain how a change in direct hourly labor costs impacts profitability. The cost of direct labor is a key component to the success or failure of Guillermo Furniture Store by positioning itself for increased productivity and engages into a different strategy to ensure its competitiveness in the market. In evaluating the cost of debt before taxes in relation to tax rates and the weight of debt, we use the cost of equity to weigh the equity of the firm itself. The alternatives of maturing matching, the conservative approach, or even the aggressive approach are different methods to consider as Guillermo Furniture Store battles severe competition and the need to increase productivity. Therefore, the alternative chosen is the maturity matching. Conclusion Analysis In the Guillermo case, the WACC is determined as the average required return for equity and the required return on the debt accumulated. The current market value of Guillermo's stocks and pricing per share, the total market value of equity it holds in terms of market caps, the next year expected cash dividend if any, and the expected constant annual dividend growth suggests that taking risks is based on special knowledge or perhaps valuable ideas, (Emery, 2007). At best, we can merely estimate a project's NPV in advance, yet we will never know the true market value, or what it is actually worth
GFS Analysis 7 until the project is complete and the returns are collected. The implications generated by a decrease of direct labor will lead to disastrous results whereas an increase of the same direct labor will strengthen the technical skill level of operations in place. Guillermo's Furniture Store believes that matching maturities of assets required a maturity matching approach to financing working capital and dealing with hedged risks. Such risks include the direct financing of seasonal variations related to the current assets and in direct relation with current liabilities that carry the same type of maturity in terms of equity securities. Furthermore, capital budgeting in relation to performance measurement has a critical role in a given organization's strategic plan.
GFS Analysis 8 References BusinessDictionary.com. (2010). Analysis of alternatives. Retrieved from http://www.businessdictionary.com/definition/analysis-of-alternatives-AOA.h... Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management, Third Edition. [University of Phoenix Custom Edition e-Text]. : Prentice Hall, Inc. A Pearson Education Company. Retrieved from , FIN 571 website.