Ongko_Furniture_Store_Recommendations

Ongko Furniture Store Recommendations Dawn Reynolds-Smith International Corporate Finance/FINGM571 June 7, 2010 Ongko Furniture Store Recommendations As a financial organizational tool, a budget represents a working document that helps in the day-to-day operations of any organization. Ongko Furniture Store’s financial reports give an overview of its current financial performance. The company also uses a flex budget that allows the company to project revenues and costs at various levels of output. This paper will therefore give an analysis of the alternatives available to the company to help the owner make an appropriate business decision. The paper will also suggest a recommendation using a pro forma cash flow budget to help justify the decision. Likewise, the paper will establish the company’s opportunities and risks associated with global growth. Analysis of Alternatives Ongko Furniture has three alternatives available to the company. The best alternative selected must consider the incremental benefits and risk-trade off determinants. Ongko’s first option, although expensive, involves investing in a high-tech solution that would increase production and reduce labor costs. The second option involves a forward vertical integration in the form of distribution and this would put the company in a new global market. The third option involves exploring the market that demands a flame retardant finish on furniture. However, this means keeping the current operations and suffering losses from the competition and changes already affecting the company (University of Phoenix, 2010). Recommendation and Justification Today, small companies seek international dimensions through exporting, outsourcing, importing, manufacturing, or forming a strategic alliance. Recent studies established that international trade increased from 7,000 in 1975 to almost 40,000 and continues to grow (Bianchi, 2007). With this in mind, a forward vertical integration with the Danish company seems feasible in increasing the company’s working capital. With the assumption that Ongko has done his homework on international trade and has weighed the risks and benefits, he could negotiate an agreement with the Danish company seeking a start up loan payable after five years. This would not only give Ongko time to increase the company’s working capital but would also prepare him for even greater expansion through globalization. One other opportunity for exploration includes raising equity through partnership with the Danish company by seeking local and foreign investors. Ongko’s Pro forma Cash Flow Budget The pro forma cash flow budget helps for future decisions as well as provides information for any contingencies. This includes the company’s current and planned financial position over a period (Emery, Finnerty & Stowe, 2007). Ongko’s pro forma cash flow budget assumes that sales will increase twice the previous year’s sales. Because of this gradual increase, price for low- and high-end furniture will also increase by 10% each year to offset operating expenses. The projection shows that sales will increase from 120% to 124% during the first four years. However, the fifth year will see a significant decline because of a decrease in sales. The fifth year would have given the company time to establish itself to the point of seeking equity from Danish or even Asian investors. These assumptions rely on the expectation that the Danish firm will allow Ongko to use his company as a channel distributor using furniture as collateral for a secured debt, deferred to year six (See attached Excel spreadsheet for Pro forma cash flow budget). International Capital Structure for Globalization Globalization, driven by policies, has domestically and internationally opened economies. Technology remains the main driver for globalization. Finding the right balance between costs and benefits means understanding how globalization works as well as understanding the policies that govern globalization according to each nation’s regulations (The Levin Institute, n.d.). In seeking partnership with the Danish company, Ongko must understand the role of integration and technical change. The expectation lies in the theory that a lower expected rate of return in one region usually transfers to a region of higher expected rate of return. However, in this scenario, Ongko has the opportunity of doing the reverse: Using vertical integration in representing himself as Denmark’s distribution center to Asia. This also gives the company in Denmark an opportunity of speedily acquiring furniture or uses the company’s own asset on a larger scale. Herein lays the opportunity too to seek from the office of Denmark, a secured debt payable after five years using furniture as collateral. Financing in Relation to International Trade According to Fagiolo, Reyes & Schiavo (2007), financing in relation to international trade refers to the ability or inability of richer countries that: 1. Share financial relationships with poorer countries. 2. Entertain financial relationships with others with secured connections; that is, allowing finances to stay among the connected or instead, shared with those in the peripheral. 3. Mutually trade or exchange with restricted and closed groups. 4. Has the most central role in the financial network. Although finance appears as a complex network for international trading, Ongko must explore the dynamic patterns of financial integration and international trade. This network will not only foster trade relations between Bali, Denmark, and Asia but also could intensify other major import and export relationships for Ongko and by large, Bali. This could also become the medium for Ongko to introduce the flame retardant finish product. Problems with Foreign Competition Problems with foreign competition seem similar to that of the local competition. These include pricing and specialization. Process or product specialization affects pricing and inevitably affects competitiveness. Other competitive strategies include cheaper labor costs; waiver in taxes and tariffs; standards and policies governing an industry; efficiency in process; infrastructure and change in technology, and assistance from government for existing manufacturers (LaBissoniere & Bowe, 2006). For Ongko to survive the competition, he must turn the threats and weaknesses into strengths and opportunities. To achieve this feat, using his proven track record will assist in highlighting his dependability and ability to produce high quality furniture. Likewise, flexibility and willingness to change as the market fluctuates will determine his willpower to remain competitive. Cost of Capital for Globalization A study by Schmukler & Vesperoni (2004), explained that advocates of globalization see the integration as a means allowing emerging economies to gain access to finance in countries with more liquidity and willingness to offer financing on a long-term basis. This also helps develop the financial system in the domestic system. Consequently, this lowers cost of capital and relaxes financing constraints. Debts issued in a foreign jurisdiction have better contractual arrangements with institutions; risk levels decrease for creditors, and debtors have the opportunity to borrow long-term. Again, this represents an opportunity to increase global growth and cost of capital for Ongko once channel distribution emerges. Likewise, this creates an option for price setting in determining a lower or higher cost of capital for the company. However, Ongko would need to keep a lower cost of capital to raise the company’s net present value (NPV). International Tax Environment Tax and non-tax factors exist within the foreign market and this affects the growth and productivity of a company that wants to do business in another market. The host country may impose tax on income or levy the tax on the subsidiary’s earnings. As Ongko tries a new business strategy, the company could establish itself as a new foreign subsidiary or as a cross-border merger and acquisition. Either way, Ongko must therefore, examine and understand the imposition of taxes as they relate to the parent company in Denmark compared with that of Bali. However, should Ongko become a distributor, the possibility exist that tax and tariffs may remain the same in his country according to his current payment but vary with inflation. Therefore, this should have little effect on his cost of capital. Problems with Labor Cost To increase efficiency companies or countries may optimally use all available resources to produce cheap goods and services. If that possibility does not exist, then they may trade with another company or country that can efficiently produce at a cheaper cost. This therefore brings to the fore comparative advantage and opportunity cost. Comparative advantage allows one to produce more products based on its ability to do so and opportunity cost refers to the cost foregone in producing that item to produce another. This promotes the idea for seeking cheap labor (Heakal, 2010). For Ongko, the company may have both—a comparative advantage and the opportunity cost. He already has the high-end custom work for his furniture and his report indicated the lowest in labor cost. Although direct cost per unit remains higher than the high-tech’s and broker’s, with time the company could see a reduction because the demand exists for furniture in Asia. This means production will increase thereby decreasing direct cost per unit produced. This will also provide capital to employ technical and skilled operators for specialization. Conclusion Capital budget poses complexity and makes business decisions challenging. Weighing comparative advantages and opportunity costs help determine project values as they become identifiable. This justifies the recommendation for Ongko to forward integrate as a distribution center. Ongko would also have the opportunity to increase working capital as well as expand the company through international trade. References Bianchi, A. (2007). Small Business: Take your business global. CNN. Retrieved from website: http://money.cnn.com/2007/07/12/magazines/fsb/going_global.fsb/ Emery, D.R., Finnerty, J.D., & Stowe, J.D. (2007). Corporate Financial Management. (3rd ed.). Pearson Education, Inc. Fagiolo, G., Reyes, J., & Schiavo, S. (2007). International trade and financial integration: A weighted network analysis. Laboratory of Economics and Management. Retrieved from website: http://www.lem.sssup.it/WPLem/files/2007.pdf Heakal, R. (2010). What is international trade' Investopedia. Retrieved from website: http://www.investopedia.com/articles/03/112503.asp LaBissoniere, M.D. & Bowe, S.A. (2006). Estimating the impact of foreign competition on the Wisconsin wood furniture industry. Part 2. A qualitative analysis. Forest Products Journal. (56), 3. Retrieved from website: http://forestandwildlifeecology.wisc.edu/facstaff/bowe/LaBissonier_Bowe_Part_2.pdf Schmukler, S.L. & Vesperoni, E. (2004). Financial globalization and debt maturity in emerging economies. Retrieved from website: http://siteresources.worldbank.org/DEC/Resources/Financial_Globalization_and_Debt_ Maturity_Schmukler_Vesp.pdf The Levin Institute. (n.d.). What is globalization' Globalization101.org. Retrieved from website http://www.globalization101.org/What_is_Globalization.html University of Phoenix. (2010). Ongko’s Furniture Scenario. Week one overview. Retrieved from the University of Phoenix, Week One rEsource. FIN/GM571—International Corporate Finance Web site.