Guillermo Furniture Store Analysis, Essay Example

Abstract

Guillermo’s Furniture Store case provides the practical concept of financial principles which are utilized in the competitive and aggressive economic environment to analyze any particular project. In this report I tried to discuss the financial management approach which Guillermo can utilize for the survival of his business. And has provided the proper utilization of the ideas to create the value and the economic efficiency of Guillermo through the analysis of different options available to Guillermo to establish and maintain his position in the market.

The Finance Concepts found in the Context of the Scenario

In any business there are three main ingredients which form a foundation for the financial decisions of the managers. These three ingredients are financial principles, financial markets, and business ethics.  In this report I will discuss how these three ingredients affected the Guillermo in his financial decision making for his Furniture Store. This case study shows that how Guillermo made decisions for the survival of his business in the region especially when it comes to the entrance of new competitor in the region from overseas. This situation was unexpected for the financial condition of Guillermo Furniture store and had come up with some new and unexpected challenges for Guillermo. In the case of Guillermo, principles of finance described the typical behavior in financial transactions and provide guidance for decision making.

In 1990 Guillermo faced severe crisis in his business. Firstly, the arrival of new foreign competitor in region with its high tech approaches in furniture market. Secondly the sleepy communities in Sonora woke up. New competitors always have advantage of applying new technologies to meet with the demands and requirements of their customers by producing customized products.  Guillermo was also facing the issue of rise in labor cost due to the inexpensive housing, new international Airport, beautiful scenery and plenty of development in the city. In businesses many financial decisions consider the value of time and money. Guillermo had three main advantages before the arrival of his competitor i.e. availability of local labor on cheap price, brand value and market condition. Since to sustain in the industry and the financial self-interest leads to rational decision making, Guillermo started thinking about to reestablish his position in the regional market to meet the challenges from foreign competitors in Sonora.  After some effective research Guillermo had three main alternatives to maintain his market share and to increase his profit. This analysis will focus on how the chosen alternative will help Guillermo to increase profit over the next five years.

Guillermo Furniture Store has 3 alternatives to maintain its business in the furniture Industry such as they can develop into broker or can make high- tech. There are different types of techniques for capital budgeting. In this report we will use following two techniques which we further used to analyze the scenario:

• Net Present Value (NPV)
• Internal Rate Of Return (IRR)

Net Present Value (NPV)

NPV is a best technique in the capital budgeting decisions. The difference between the present value of cash inflows and the present value of cash outflows is known as NPV. (Fabuzzi, 2003).

Net Present value can be calculated by the following formula:

In the above formula CFt is derived as expected net cash flow at Period t, where k is project’s cost of capital and n assumed as the life of the project. Investor’s cash position decreases in this project therefore cash outflows will be treated as negative.  In case of Guillermo Furniture Store in all the alternatives CF0 will be negative, whereas in few projects the cash flow remains irregular. (Brigham, 2004).

In the current scenario NPV is used as capital budgeting technique by the managers.

Internal Rate of Return (IRR)

IRR method is also used as capital budgeting technique in particular project to make net present value of cash flows equal to zero.

IRR can be calculated by the following formula:

Where CFO is the cash out flow from the project and CFI is the cash inflow from the project.

Sensitivity Analysis

In this case if Guillermo will chose to be remaining same, the net income before taxes in current setup will be $46,118, for hi tech solution it will be $213,175 whereas if he considered to be a distributor then net income before taxes will be $65,041.

In the hi tech solution or to be the distributor, the sales forecast for both the situation will be 3,102 but it will remain at 2,787 for mid-grade for the current situation, the sales forecast for high-end for the hi-tech solution and for distributor representative solution will be estimated as 517 but it will remain at 421 for high-end in the current scenario.

However, in case of hi tech and distributor process the prices of the projects will be reduced by 10% due to the increase in the supply in both cases

Due to deprecation the plant overhead increases in high-end and broker. In case of hi-tech solution and distributor the depreciation is $466,667 whereas for the current scenario the depreciation is calculated as $50,000.
If Guillermo chose the hi-tech solution for Guillermo Furniture store or to become the distributor then he might require additional maintenance staff for Guillermo furniture store, which is another cost effective issue for Guillermo. In both the process required position of maintenance staff will cost additional salary of $45,000 whereas for the current scenario there is no such requirement of any maintenance staff.

Furthermore, the cost of utilities will increase 3 times of the production if he chose hi-tech scenario whereas, in case of distribution scenario the cost of utilities will likely to be reduced to $4,502 from $9,000.
Similarly, to calculate the net income after taxes we will subtract the income tax value from the income before taxes.  Income after taxes will be calculated as $26,748 for current situation, $123,642 for hi-tech solution and $37,724 in case of distributor.

The sensitivity analysis of the current operation of Guillermo furniture store shows that the Guillermo’s current asset will increase by $55,312 during the tenure of 2010 and 2011. However, the total assets of Guillermo will increase by $5,312. Guillermo’s total current liabilities will increase by $7,803 during the years ended 2010 and 2011 whereas the total liabilities of Guillermo decrease by $21,437.

In case of Guillermo furniture store, total equity of Guillermo increased by $26,748; the main reason behind the increase in equity is an increase in the constant earnings.

Similarly, the production of mid-grade shows a favorable variance of 215 in flex budget, whereas the production of high-end units shows an unfavorable variance of 117. And the labor time will be unfavorable for mid-grade i.e. 1.50 and 2.00 favorable for high end.

Conclusion

With the above analysis of alternatives for Guillermo’s Furniture, and the elements of corporate finance, we evaluate and distinguish the best alternatives for Guillermo in the industry and Guillermo should adopt the partnership, new technology and patent. These are the best alternatives that will help to solve and understand problems in which the Guillermo Furniture Store will find solutions to overcome and adapt to the new challenges in the market and success in the furniture industry.

References

Brown, & Reilly. (2006). Investement Analysis and Portfolio Management. Thomson ONE -Business School.

Emery, Douglas; D. Finnerty, John & John D. Stowe. (2007). Corporate Financial Management (3rd ed.). Chapter 2: The Financial Environment: Concepts and Principles. Prentice Hall, Inc: A Pearson Education Company:

Fabozzi, F. J. (2003). Financial management and analysis. New Jercy: John willy and sons.