Guillermo Furniture Store Analysis

Running Head: GUILLERMO FURNITURE STORE ANALYSIS

Guillermo Furniture Store Analysis Christina Cardwell FIN/571 University of Phoenix Eric Hohl September 19, 2011

Guillermo Furniture Store Analysis Guillermo Furniture Store Analysis Week one individual paper was centered on Guillermo Furniture Store location, the production of work and the company finance. Week three individual paper will state three alternative measures for Guillermo Furniture Store working capital policy by weighting the average cost of capital, and by implementing multiple valuation techniques toward reducing the business risk. Business within Guillermo Furniture Store started to decline in the early part of 1900s. The effect of outside influences has opened up a new era of business for foreign competitors. The competitors have allowed their customers to crave the new technology of produced furniture by creating a lower price range. The simulation stated that housing were inexpensive, the location of business had mild weather, and beautiful scenery, along with uncongested roads a new International Airport and plenty of new development (University Of Phoenix, 2011).

Guillermo Furniture Store Analysis Alternatives To make a profitable decision the implementation of alternative needs to be considered. The three alternatives investment projects (the currently used approach, the high-tech approach, and the broker approach) needs to be categorized in a distinct order. The currently used

approach consists of the company not changing their position, they will continue with their business lifestyle since the 1900s. High-tech alternative will allow the company to produce more custom furniture at a lower cost. The broker alternative will have allowed Guillermo to become one another store. The best alternative must be chosen to keep a productive business running successfully. The implementation of capital budget needs to be considered also with the three alternatives. 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 three criterias that have to be implemented in capital budget are the Net Present Value (NPV), the Weighted Average Cost of Capital (WACC), and the Internal Rate of Return (IRR). Net Present Value (NPV) Net Present Value is defined as the difference between what something is worth (the present value of its expected future cash flows, it market value) and what it costs (Emery, 2007, p. 221). The NPV calculation is the most used approach to discount cash flow toward helping to find the value of the intended projected cash flow within the present and future world of business finance. If the NPV is positive Guillermo would likely take on the project, in this case he would buy a high tech equipment because the cash flow from the equipment will benefit his customers and his business successfully. By creating a five year budget Guillermo can predict the next five years cash flow within the business.

Guillermo Furniture Store Analysis If Guillermo decides to invest a total of 5,000,000 for an initial investment with the preceding capital at 14.36% the next five years cash flow will be set-up as this: Year Project HighTech (Initial investment) 0 1 -5,000,0000 511,672 2 2,015,316.45 3 2,179,707.32 4 2,282,181.50

5 2,395,212.47

Guillermo Furniture Store Net Present Value is a total of $108,812.95. This information will allow Guillermo to see if he decides to choose the high-tech equipment. His company will see from firsthand experience an increase of value rather than decrease. Weight Average Cost of Capital (WACC) Weight Average Cost of Capital is defined as the overall required return on the firms as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers (WACC, 2011). In general WACC is another way business can evaluate their proposed projects and capital budgeting. It is a discount rate expressed in percentage rates. Using the Weight Average Cost of Capital on Guillermo furniture store will determine if the investment or purchases are valuable enough for him to take on.

Total Market Value of Equity Total Market Value of Debt Cost of Debt Corporate Tax Rate Cost of Equity WACC

300,000,000 400,000,000 8% 35% 18% 12.5%

Guillermo Furniture Store Analysis

The Weighted Average Cost of Capital approach is used in the above calculation to express the high-tech project if Guillermo implements within this business. WACC will be used in conjunction to the internal rate of return (IRR) when decisions are made when dealing with capital budget. Overall it is considered a good investment (the new project) if the IRR will exceed the WACC. Techniques In Reducing Risks. To keep risk at a minimum a company such as Guillermo Furniture Store needs to include the aspects of their financial decision. By identifying the risk in each project Guillermo needs to decide which techniques should be used and the amount of risk that the company is prepared to take on at the moment. Different valuation techniques can be applied to this alternative. To ensure that the profit is profitable Guillermo can consider implementing several valuation techniques. He must also make a determination to the amount of risk that his company can handle because the risk factors are different considering the type of project. Valuation techniques that can be considered within the reduction of risk are Capital Budgeting, Net Present Value, and Weight Average Cost of Capital. If the investors and Guillermo apply one of these methods they will likely know the estimated time it will take the company to make a profit from the initial projected fee. The longer the time means the higher the risk will be, by examining it from a projected stance one will be able to see if the investment is worth the effort. If Guillermo decides to use the technique designed to monitor the Weight Average Cost of Capital and the Internal Rate of Return, he will likely make a determination that favors the IRR versus the WACC. If the IRR is higher than the WACC this indication will tell the risk involved within the project that the risk is lower.

Guillermo Furniture Store Analysis Sensitivity Analysis Sensitivity Analysis is defined as a technique used to determine how different values of an independent variable will impact a particular dependent variable under a given set of assumptions (Sensitivity Analysis, 2011). Conducting a sensitivity analysis will also allow Guillermo to see the aspects of the new way of business. In a sense, it will allow the

management department to make a sound business decision without any doubt. Guillermo will be able to see on firsthand the assumptions that will benefit the company along with those that will not from a financial forecast prediction. The values pinpointed out within the Sensitivity Analysis from the company income statement will examine the effect that the company has with their finances whether it is large or small while indicating the importance of value. By applying this report to his projects Guillermo will be able to determine from firsthand experience, which of his projects are profitable and practical. Conclusion Within a competitive market setting, Guillermo Furniture Store has decided to take the next step to stay ahead of the competition. By investigating options that are designed to make more money will benefit the company overall. Three alternatives have been introduced to the company and Guillermo must choose the one that will provide his company with a higher income rate and a lower risk.

References R. Emery, D. Finnerty, D. Stowe. (2007). Corporate Financial Management (3rd ed). New Jersey: Pearson-Prentice Hall, Inc.

Guillermo Furniture Store Analysis Sensitive Analysis. (2011). Investopedia. Retrieved from http://www.investopedia.com/terms/s/senstivityanalysis.asp University of Phoenix. (2011). Guillermo Furniture Store Scenario. Retrieved October 16, 2011 from University of Phoenix, Week four, FIN/571-Corporate Finance Course website. Weight Average Cost of Capital. (2011). Investopedia. Retrieved from http://www.investopedia.com/terms/w/wacc.asp