Guillermo_Store_Analysis

Abstract Independent business owners should have an effective business plan in place when starting a business. A competitor is one major reason for an alternative business plan in the event of slow profits. Aggregate planning should be included in the business plan. The Guillermo Furniture store is one of the largest furniture manufacturers independently owned by Guillermo Navallez in North America. Guillermo has been faced with changes such as a new competitor and rising costs. This paper will review the various options that management staff at Guillermo Furniture Store can use to assist Guillermo in maintaining its current income and to also increase its earnings in the future. This paper will also determine the weighted average cost of capital based upon existing operations, present calculations of net income and an income statement for each of the alternatives from the data provided, and discuss the factors affecting the risk of a project and how they might influence a project’s risk (discount rate) versus the firm’s risk (WACC). Guillermo Furniture Store Analysis 3 Analysis of Different Alternatives Guillermo Furniture Store alternatives are the three philosophies of financial working capital; the aggressive approach, the maturity-matching approach, and the conservative approach. These three approaches can capitalize on stockholders wealth and can be the driving force of a successful company. According to the aggressive approach long-term funds are used to finance only the core or fixed portion of current assets. Organizations tend to use the aggressive approach because they usually benefit from the decline in interest rates. Organizations that use long term financing are legally bound to the high interest rates, but in many cases the organization does have the option to refinance the debt. The conservative approach allows organizations to alternate between short-term financing and long-term financing. According to conservative approach the total current assets are financed from long-term sources and short-term sources are used only in emergency situations. Long-term financing is used to finance all of the firm’s long-term assets, all of its permanent current assets, and some of its temporary current assets (Emmery,Finnerty,& Stowe, 2007). The maturity-matching approach permits a company to use its current assets the firm finances long-term assets with long-term sources of funds. By matching its seasonal variations in current assets with current liabilities of the same maturity, the firm essentially hedges against changes in short-term interest rates. When using this approach organizations avoid danger by correlating the maturities of assets and liabilities, thereby exhausting long-term assets for long-term liabilities. Guillermo has the option of continuing with his current operations, merging his company with the competitor, or transitioning his business into a distribution company. Guillermo Furniture Store Analysis 4 Guillermo Navallez does not like the idea of a competitor taking over the furniture business and he is also not interested in merging his company with another. Mr. Navallez should consider the principle of Risk-Return Trade Off, which states that if you want to have a chance at some really great outcomes, you have to take a chance on having a really bad outcome (Emery, Finnerty, & Stowe, 2007). Sensitivity Analysis The sensitivity analysis discusses the difference between alternatives that Guillermo Navallez can choose from. Because of the competition that has come into the area Guillermo Navallez has to make some wise decisions about the finances for his company. Most organizations use the aggressive approach in short-term financing for assets because the organizations benefit more through using this approach. Guillermo Navallez should consider short-term financing for the working capital to implement the strategic management plan because long-term financing would cause Guillermo to increase future debt. Guillermo Navallez has considered the possibility of transitioning his current business to a distribution company. Based on the calculations of the net income, it seems that Guillermo should consider operating with the current alternative as opposed to the high or the broker alternatives. Guillermo needs to create a strategic business plan to improve profits for his organization if he wants to stay in the furniture business. The broker alternative would be an acceptable alternative, considering the net income is less than choosing the high alternative, but the loss is much less by choosing the current alternative. Guillermo’s operations seem to be taking less of a risk by using the current project alternative. Guillermo Furniture Store Analysis 5 Weighted Average Cost of Capital The weighted average cost of capital can be described in terms of financing rates. Therefore, it can always be represented as the weighted average cost of the components of any financing package that will allow the project to be undertaken (Emery, Finnerty, & Stowe, 2007). The following is the weighted average cost of capital based upon Guillermo’s existing operations using the formula WACC = (1 − L) re + L (1 − T) rd. Current- (.161) (.165) + (.838) (.075) (.58) =.0265+.0364=.062 Hi= (.392) (.192) + (.607) (.075) (.58) =.101=0.075+.026=.101 Broker= (.324) (.138) + (.675) (.075) (.58) =.044+.029=.073 Guillermo would have to choose which of the above three alternatives would be the best capital cost of budgeting for his organization. Of the three the current 6.2% WACC would be considered the best alternative for Guillermo Furniture as compared to the hi alternative, which is 10.1% and the broker, which is 7.3%. The financial statements play an important role in any organization. It determines the financial status of the organization and whether the organization should continue with business as normal or choose an alternative business plan. All organizations should have a backup plan in the event of competitors or an economic downfall that may occur. Guillermo Navallez must create a strategic business plan to stay in business and compete with the new organization that has entered the market. Guillermo’s Furniture Store is valued by its expected cash flows or its required rate of returns on those cash flows. Estimating the cost of capital and value in regard to assets are influenced by financing and investment decisions. The following is Guillermo Furniture Store’s Income Statements for each of the three alternatives. Guillermo Furniture Store Analysis 6 Income Statements for each alternative Current Hi Broker Revenue 265,282 891,543 663,663 Plant Overhead/Yr Salaries 50,000 95,000 95,000 Utilities 9,000 27,000 4,497 Benefits 103,730 82,412 21,644 Insurance 3,000 15,000 15,000 Property Taxes 975 3,900 3,900 Depreciation 50,000 466,667 466,667 Supplies 6,000 6,000 6,000 Total Expenses 222,705 695,979 612,708 Net Income 42,577 195,564.33 50,955.30 From the above calculations Guillermo’s current revenue is 265,282 minus his total expenses of 222,705 the net income (loss) is 42,577. The revenue for the broker alternative is 663,663 minus the total expenses of 612,708 and the net income (loss) is 50,955.30, which would also be an acceptable alternative for Guillermo and the revenue for the hi alternative is 891,543 minus the total expenses of 695,979 and the net income (loss) is 195,564.33, which is extremely high in running an organization. The cause for the differences in the net income is the changes in the expenses such as the utilities, benefits, insurance, and taxes from year to year. Making careful financial decisions will help Guillermo Furniture Store reduce mistakes in operating and reduce imperfections with the finances, which will affect the future of his business. Guillermo Furniture Store Analysis 7 Factors affecting risk To find the best option, there are various options that can be used from capital budgeting techniques; including: simple payback, discounted payback, and net present value. In the Simple payback capital budgeting technique refers to the amount of time it will take Guillermo to recover his original investment. Therefore, the payback method may result in a bias towards accepting short-term projects and rejecting long-term investments. The payback method ignores the timing of cash flows within the payback period. Finally, the payback method ignores the riskiness of future cash flows. The discounted payback is the amount of time it takes for the project’s discounted cash flows to equal the project’s initial cost. The discounted payback method; however, ignores all the cash flows after that date. Although the discounted payback period provides a better measure of recouping the initial investment when compared to the standard payback method, it provides a poor compromise between payback and NPV (Blackwell publishing). The net present value is the difference between what something is worth and what is actually cost (Emery, Finnerty & Stowe, 2007). Guillermo’s current operations Guillermo Furniture Store finances prove that he could improve his current business operations to maintain profitability and potential growth. Conclusion Although Guillermo Navallez has different options that he can choose from to increase profitability for his furniture business, he seems to be satisfied with his current operations. Guillermo Navallez must make adjustments to his current plan for to stay ahead of the competition and to keep up with current social and economic changes. Investing in more high- tech equipment will assist him in making operations smoother than in the past for him and his Guillermo Furniture Store Analysis 8 management staff. Review of the residual income for Guillermo, it seems that the business is not doing too well. Guillermo Navallez may want to keep his options open and consider making some changes in his current business plan. Identifying potential risk, keeping accurate financial statements, and considering other alternatives to increase profits will assist Guillermo in maximizing his business to its full potential.