Chancie M. Garbe
November 26, 2012
Guillermo Furniture Store Scenario: Alternative Analysis
Considering today’s economic fluctuations and the increase in the competitive markets, businesses need to apply every strategy, take advantage of every approach, and use every tool in their arsenal to survive. In order to survive, the business will have to deal with long-term investments and the process for this starts with capital budgeting. According to Emery, Finnerty, and Stowe (2007), capital budgeting is a necessity because assets basically define a business, but managers will have to analyze each project to determine accurately the cost of capital. The Guillermo’s Furniture Store scenario will provide the information and data for this paper; which focuses on analyzing the cost of capital and calculating the net present value (NPV) for three different alternatives the store needs to consider in order to keep the doors open. Plus, this paper will provide an overview of Guillermo’s store, a sensitivity analysis, as well as discuss different valuation techniques available to help reduce risk. Guillermo Overview
Oftentimes, a business at some point-in-time should consider the economic environment within their market, and take into careful consideration the competition. However, a business may have no choice but to evaluate the competition because of various circumstances such as those Guillermo’s store faces. For example, the developing new competitor, the influx of people, and the increase in labor costs are circumstances that forced Guillermo to evaluate the competition and make a decision. After dealing with shrinking profit margins, the owner of the furniture store evaluated the competition to see how these other organizations handled the changes in the economy (University of Phoenix, 2012). Simply, Guillermo had to make decisions about the survival of his business with the application of different financial principles and concepts; he can accurately assess the future route for his store. So Guillermo analyzes three different alternatives, which differ in areas including the structure of the company, what equipment the company uses, and helping another business distribute the product. Guillermo will have to decide the alternative that is best for his business. According to Emery et al. (2007), “a firm’s choices of which products to produce and which services to offer, then, are capital budgeting decisions,” and these choices will intertwine with every other decision the firm faces (p. 187). Sensitivity Analysis
Managers considering investments need to use the techniques available to offer insight on their investment decisions. Oftentimes, a business can use the sensitivity analysis to help estimate the amount of money available to invest and the amount of revenue the project has the potential of generating. According to Emery et al. (2007), the purpose of the sensitivity analysis is to answer the “what if things do not as planned” question; basically, the contribution margin determines the NPV sensitivity. In order to develop a feel for the potential project, Guillermo can use the contribution margin-the difference between revenue and variable costs- to determine how sensitive the NPV is to variations in sales. For example, to estimate the sensitivity of Guillermo’s current business, the general sales levels will be $2,500, $5,000, and $20,000: a. Current Sensitivity: contribution margin= net revenue minus variable costs and in this case the net revenue prior to taxes is $3,937.69 and the total variable costs compute to $315.52. Therefore, the contribution margin is $3,621.69 or ratio 0.90. So the sensitivity for low value is 0.9($2,500) - $3,937.21= $-1,687.21. The sensitivity for the medium value is 0.9($5,000) -...