April 29, 2013
Guillermo Furniture Store Analysis
Guillermo Navallez owns a furniture store in Sonoma, Mexico near his residence. He produces tables and chairs from the available timber supply in the area. Until the late 1990s, Guillermo was enjoying a lucrative business because labor costs were low, and he could charge a premium price for his handcrafted and high quality products (University of Phoenix, 2010). Guillermo is noticing a decrease in his profit margins because of a change in the furniture market environment. A competitor from overseas that uses a hi-tech production method has moved to the area (University of Phoenix, 2010). Also, the area of Sonora, Mexico is growing in population and development. These two situations have a direct effect on Guillermo’s furniture business. He must determine how this change in market environment affects his business and develop an alternative business strategy to compete in the new environment. Issues Affecting Guillermo’s Business
The foreign competition that has moved into the area provides a hi-tech approach to production that provides furniture at a low cost with high specifications (University of Phoenix, 2010). This creates a pricing issue for Guillermo. Previously, Guillermo could charge a higher price for custom tables and chairs. Because his low-tech production method is time and labor intensive it will be difficult to lower the price of his furniture. To remain competitive, he can no longer demand a higher price for his custom products because the competition can provide the same service at a lower cost. Labor Costs
Sonora, Mexico with its mild weather and beautiful scenery, is growing and providing inexpensive housing, un-congested roads, a new International Airport, and development (University of Phoenix, 2010). This new growth is, in part because one of the largest retailers in the nation moved its headquarters to the area. Labor costs are increasing as a result of the growth of the community. Because of his labor needs, this poses a problem for Guillermo’s business. He can no longer pay low wages because his competition can pay more for skilled labor. Alternative Strategies
Guillermo is facing a changing market environment and needs to make some strategic decisions to remain competitive. He will need to look at alternative strategies for his business to help decide the most financially advantageous strategy that will allow him to reach his goals. Capital budgeting and valuation analysis will show Guillermo the risks and rewards for different products and services that each alternative plan offers. Using his balance sheet and income information, Guillermo can calculate the weighted average cost of capital (WACC) and the net present value (NPR) for each alternative. According to Investopedia (2013) “The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing” (para. 1). The NPV is equal to the “Present Value (PV) of the Cash Flows discounted at WACC” (Investopedia, 2013, Weighted average cost of capital, para. 2). Another useful form of analysis is a sensitivity analysis, which can help predict an outcome when a variable is changes, such as a 50% decrease in production. By looking at the WACC, NPR, and sensitivity analysis, Guillermo can determine the cost of capital or the opportunity cost for each alternative. The process of corporate valuation and determining the cost of capital for a capital budgeting project is important because “the firm’s value depends only on the size of its expected future cash flows and the required return on those expected future cash flows” (Emery, Finnerty, & Stowe, 2007, p. 189). After analyzing each alternative, Guillermo can decide what level of risk he is comfortable with. His alternatives are to continue the current strategy, embrace a hi-tech...