Guillermo_Furniture_Store

Guillermo Furniture Store Recommendation Paper University of Phoenix Corporate Finance FIN 571 Introduction Guillermo Navallez, and his business Guillermo's Furniture Store located in Sonora, Mexico, have fallen victim to several changes in the market in which he does business. These changes include expensive technological advances made by his competitors and a changing labor market which have forced Guillermo to carefully evaluate and analyze his business from different financial perspectives. This business assessment will analyze Guillermo's alternatives based upon working average cost of capital (WACC), valuation techniques designed to reduce risk, net present value and a capital structure. This analysis will provide him the financial information needed to justify an informed decision with regard to the future of him and his business. Alternative One – Capital Investment Based on the new technologies that some of his competitors are bringing to the industry of furniture making, option one could be to invest significant capital into the business to bring the operation up to state of the art. This would include plant upgrades and purchase and installation of computer controlled laser lathes. This option would require a large cash outlay or assumption of long term debt since these upgrades would be extremely costly. The capital investment, however, could be offset by a reduction in labor and a decrease in production costs resulting from 24 hour running capability. In an effort to gain clarity, the business must perform an analysis to determine what risks exist under this option and whether or not the business is willing to assume that risk. In obtaining the WACC, we will assume that new facility upgrades and one new laser lathe will cost a total of $1.0 million and the new debt will carry an interest rate of 7%. Using the following formula the weighted average cost of capital can be calculated: Cost of Equity (Re) = Dividends per share/Current market value of stock + growth rate of dividends. Re = $1.00/$10.00 + 0 Re = 10.0% Cost of Debt (Rd) = Kd(1-t) Rd = 7% (1-0.42) Rd = 4.1% WACC = E/V*Re + D/V*Rd * (1 – Tc) WACC 23.58%*10% + 110.94%*4.1% * (1-42%) WACC = 2.36% + 4.56% * .58% WACC = 4.01% Based on calculations above, Guillermo's furniture Store should receive about 4% as a return on its $1 million investment into the company in the form of facility upgrades and new equipment. Alternative Two – Merge or Sell Guillermo's Furniture Store can seek to merge with one of these new and technologically advanced companies in an effort to preserve his place in the industry. This would provide a positive impact to both business entities. The new furniture makers would gain the expertise and craftsmanship that Guillermo's company would bring and Guillermo would advance their capabilities through the technology that was mentioned above. Under this alternative, the initial cash outlay would not be as great as in option one; however Guillermo may need to pay an intangible price. As noted in the scenario, this option would increase his management responsibilities greatly thereby reducing time that he could spend with his family. Guillermo's decision to sell his business would include several variables. These variables would include the value or market price of the business as it exists today, the amount of debt the new owner would be assuming, value of assets, value of the customer base, and other considerations. The sale of the business would result in an influx of cash to the business which could be invested in stocks, bonds, etc. However, the sale of the business would also eliminate future profits (or potentially losses) resulting from the businesses success or failure. From a pure risk perspective, the sale of the business would present the least amount of risk to Guillermo. There may be opportunity costs associated with selling the business and not investing to the level of the businesses potential profitability, however, the risk to Guillermo's assets would be minimal. A decision to merge with another company would present different challenges. These would include stock splits, facility maintenance, employee retention, and ownership leverage. The risk under this scenario would be greater then had Guillermo sold the business outright. Recommendation for Guillermo Furniture Guillermo Navallez’s alternatives offer many possibilities as well as create further obstacles. The alternative to merge or sell would create more opportunity costs, both in business and in his quality of life, to be considered. The process of Capital Investment would be the most viable recommendation for the Guillermo Furniture store at this juncture in the company’s financial standings based on, again, a 4% return on its $1 million investment into the company and although the capital investment is costly, the projected financial outcome will not only bring Guillermo Furniture leverage against its competition, it will also bring stability and viability within the industry and current economic market. During the initial transition to the new processes, Guillermo Furniture should continue normal processes with the addition of focusing on increasing product knowledge of their flame-retardant products and services offered to gain market share. The project management aspect would be carefully monitored to ensure that all benchmark points are being met and successfully being implemented. The Gantt chart will be utilized as a cross-referencing tool that allows the company to monitor the project management of the restructuring thus allowing the organization to manage the existing flow success or any gaps that could potentially cause issues during the projected goal timeline of the restructuring. Gantt Chart-Project Implementation The Gantt chart below will monitor the entire process of the Company’s restructuring which will have a completion goal of two years in order to remain under budget. In the restructuring, the plant equipment will be replaced with newer technology and new laser lathes will be added to assist the new processes and the implementation of the laser lathes is projected to take approximately six months. The addition of several facility system upgrades will be incrementally installed over a period of one year and followed by personnel hiring and training of the new processes within the proceeding three months. Any issues which may affect the projected timeline of the project management will be audited and adjusted dependent on need. The entire process is projected to be completed within a two year timeline. (Gantt Chart: Guillermo Furniture) Pro Forma Cash Flow Budget Guillermo Furniture has a five-year planning model that includes key details of the business. The firm is exploring its options over the next few months in order to make a decision on whether to keep the business or sell. The numbers below are based on setup data that was taken in preparation for this study. Right now Guillermo Furniture is taking a hard look at all options that concern his furniture business. Pro forma financial statements show the effects of the firm’s decisions on its future financial statements. Firms use pro forma financial statements throughout the planning process to assess the effects of alternative decisions on various items of interest, such as sales and net income. In addition to helping in the decision-making process, pro forma statements also help the firm create contingent plans for responding to unexpected situations, (Emery, Finnerty, Stowe, 2007.) Guillermo’s plan includes pro forma financial statements, which show the firms setup information which includes the current sales promotions and forecast. As will be seen production can be increased by 50% and brokers anticipate the same level of increase in production. There is no material cost for brokered units and the labor rate is increased due to the technical skill level of operators, (myresource.phoenix.edu.) There is no labor cost for brokered units and production times are 20% of original and are equal to the mid-grade level. The broker cost for Mid-Grade is based on net FOB destination charged. Freight terms are expressed as either FOB or shipping point or FOB destination. The letters FOB means free on board, this means that goods are placed free on board the carrier by the seller and the buyer must pay the freight cost, this is an agreement between the seller and buyer and is indicated on the sales invoice, (Weygandt, Kieso, Kimmel, 2002.) Guillermo Furniture's Five YEAR 1 2 3 4 5 Year Plan Production Mid-Grade $2,609.00 $3,913.50 $5,870.25 $8,805.38 $13,208.06 High-End 522.00 $783.00 $1,174.50 $1,761.75 $2,642.63 Direct Materials ($)/Unit Mid-Grade 140.00 140.00 140.00 140.00 140.00 High-End 250.00 250.00 250.00 250.00 250.00 Direct Labor ($/HR)/Unit 15.00 $40.00 $106.66 $284.42 $758.44 Labor Time (Hrs)/Unit Mid-Grade 20.00 20.00 20.00 20.00 20.00 High-End 30.00 80 80 80 80 Direct Cost/Unit Mid-Grade 440.00 300.00 360.00 431.99 518.39 High-End 700.00 410 410 410 410 Price/Unit Mid-Grade 509.00 459 414 373 336 High-End 879.00 792 713 643 579 Plant Overhead/Yr. Salaries 50,000 95,000 140,000 185,000 230,000 Utilities 9,000 27,000 81,000 243,000 729,000 Benefits 106,760 117,436 129,180 142,098 156,307 Insurance 3,000 15,000 27,000 39,000 51,000 Property Taxes 975 1,608.75 2,654.44 4,379.82 7,226.71 Depreciation 50,000 49,800.00 49,100 48,400 47,700 Supplies 6,000 6,000 6,000 6,000 6,000 Income Tax Expense 20,044 28,462.59 34,155.11 40,986.13 49,183.36 273,459 919,083 1,564,707 2,210,331 2,855,955 225,735 698,219 1,170,703 1,643,187 2,115,671 47,724 49,156 50,630 52,149 53,714 A 45, 000 a year maintenance position was added to handle equipment, the cost of equipment consist of the cash purchase plus certain related cost. These costs include sales taxes, freight charges and insurance during the transit paid by the purchaser. Cost also consists of expenditure required in assembling installing, and testing of the units. However, motor vehicle licenses and accident insurance on company cars and trucks are not are not included in the cost of equipment. Utilities are expected to be three times current at full production and benefits are expected to require about 19% in wages. Insurance will increase by 12, 000 with the addition of equipment and building expansion. Property taxes are 6.5 percent with a one percent assessment of original value on plant and equipment. Buildings are assessed at 30 years and equipment is at 10 years using the straight line method of depreciation. Supply expense is miscellaneous with no variation; taxes are 42% of net income. Conclusion Guillermo Furniture had two viable alternatives that could help them increase their profitability on the long run. These alternatives were either to get involved with capital investment, and the second option was either to merge or even sell. After careful consideration using several financial tools such as the creation of a Gantt chart as well as the creation of a Pro Forma Cash Flow Budget, the recommendation is for Guillermo Furniture Store to get involved in the process of Capital investment. Although this alternative will be costly in the short term it will create a great amount of leverage between them and their competition. References Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management (3rd ed.). Morristown, NJ: Wohl Publishing Inc. Investopedia (2011). Retrieved on December 8, 2011 from http://www.investopedia.com/terms/s/sensitivityanalysis.asp#axzz1epggBlMr Value Based Management (2011). Retrieved on December 8, 2011 from (http://www.valuebasedmanagement.net/methods_npv.html Corporate Financial Management, Third Edition: Emery, D.R., Finnerty, J.D., Stowe, J.D., (2007) Accounting Principles, Sixed Edition: Weygandt, J.J., Kieso, D.E, Kimmel, P. Kimmel., (2002) Retrieved December 12, 2011 https://portal.phoenix.edu/classroom/coursematerials/fin_571/20111101/