Executive Summary: Guillermo Furniture

Capital Budget Recommendation

Guillermo Furniture is located in Sonora, Mexico. It was founded by Guillermo Navallez. The company manufactures midgrade and high-end sofas and the company and its owner is being pressured by the increased competition that is moving its way into Sonora, Mexico. Guillermo has hired an accounting firm to explain which option would be the best move for the company financially. The options presented to Guillermo are; consolidating into a larger organization by merger of acquisition, going with a high-tech solution like his foreign competition and decreasing production cost, moving his company from primarily manufacturing to primarily distribution or continue to work on creating the
For Guillermo Furniture the future inflows of cash must be compared with the interest rate that Guillermo could receive on the investment somewhere else.
Internal Rate of Return is another part of capital budgeting. It is a discount rate used to make the net present value of cash flows for a project zero. The higher the internal rate of return the more desirable the project is ("Investopedia", 2014). The greater the IRR is than the required rate of return on either opportunity, the more advantageous it is for Guillermo to embark on that project. Quite often, the company 's cost of capital is used as the required rate of return to assist in determining profitability of the project.
Payback Method is one of the lower methods to use. Its meaning is the same as its name pay back. Many companies use this method because it is simple its gaining back your initial investment cost ("Investopedia", 2014). This method would provide Guillermo with enough time to recover its initial investment cost. The shorter payback periods will benefit Guillermo better because it will allow the company to next focus on making larger
If Guillermo decides to purchase the new equipment in order to compete with his foreign competitor this will prove to be more beneficial for the company because the increases in production will result in lower prices per unit, labor cost will also drastically decrease because most manufacturing of parts will be done electronically. The Net Present Value technique will show whether purchasing the equipment in order to decrease production and labor cost is worth it. Out of the other scenarios being weighed by Guillermo the net present value will help with those as well. The Payback option is also a useful option for Guillermo because with purchasing if the product is not purchased in full you are given a timeline to have the purchased paid for so Guillermo will be able to have an outline of the payback period. Also, because short payback periods are looked upon more heavily a lot of the investments being made by the company will likely have short payback period. The options that don’t seem to fair to well for Guillermos scenarios are Internal Rate of Return, and the unadjusted rate of return. These two capital budget techniques do not work well with the scenario for Guillermo to have new technology or equipment added to the shop in order to decrease labor and production cost and to increase the profits that will be seen with the