University of Phoenix
Guillermo Furniture Store is a furniture manufacturer in the city of Sonora, Mexico. Until the late 90’s, Guillermo Navallez had been a very successful business owner. Sonora provided a good supply of timber, the labor was considerably inexpensive, and Guillermo could sell his handcrafted products at a slight premium because of their quality.
During the late 90’s two events occurred causing a dent in Guillermo’s business and profits. The first event was a new foreign competitor entering the market. The new competitor used a new high-tech approach to produce customized furniture at rock bottom prices. The second event was one of the largest retailers located a few miles from Guillermo began to have a major impact on the communities in Sonora. “With inexpensive housing, mild weather, beautiful scenery, un-congested roads, a new International Airport, and plenty of development, an influx of people and jobs raised the cost of labor substantially. Guillermo watched his profit margin shrink as prices fell and cost rose” (University of Phoenix, 2010).
Guillermo must find a solution to deal with the new changing market. He must research alternatives to make a profitable decision; the alternatives are categorized as different investment projects. Project one, the first alternative, Guillermo maintains his current position and continues operating the same way. Project two, the second alternative, Guillermo begins using the high-tech approach like his competitor; he produces customized furniture at a lower cost. The third alternative, he becomes a furniture broker for another company.
Guillermo must decide on the best alternative that would help increase his profits and take back his competitive advantage in the furniture market. This paper will explore and analyze the different alternatives available to him. Based on the analysis Guillermo can decide which alternative would be best to help him rebuild his business, re-grow his profits, and reduce his costs.
Capital budgeting techniques should be applied to the different alternatives to determine the most successful and predict and reduce future risks. When making capital budgeting decisions “The objective is to find investment projects that will add value to the firm”, “These are projects that are worth more to the firm than they cost—projects that have a positive NPV” (Emery, 2007, p. 216).
The first technique is the net present value. The Net Present Value (NPV) is one of the most used and reliable methods when managing capital budgeting decisions. NPV is defined as “the difference between what something is worth (the present value of its expected future cash flows—its market value) and what it costs” (Emery, 2007, p. 221). NPV also uses discounted cash flow techniques to find the value of the project’s cash flow in the present and future. Calculating the NPV will help Guillermo determine which project to choose. If the result of a particular project’s NPV is positive then the company should take on that project. The formula for NPV is: NPV= Total PV of future cashflows – initial cashflow (CF0).
Weighted average cost of capital (WACC) is another widely used method. WACC is the required return on the firm as a whole; often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. By calculating a weighted average, the company can determine the interest for every dollar that is financed.
Techniques in Reducing Risks
Every decision made consists of pros, cons, and risks. It is necessary to implement methods to minimize risk. For each project, techniques are needed to identify risk. Each project is associated with certain risks; Guillermo must determine the amount of risks the company can afford.
There are several valuation techniques that can be applied to this scenario. Other...