Making a sound financial decision is a vital component of the success of a business. The business must conduct market research, description of products, services and marketing strategies, and setting principles for the business’s success. Expenses should be noted prior to writing a financial plan. The goal of a business is to operate on a predefined budget. Ensure there are no undefined or hidden cost that could cause problems later. The business plan helps the business to make day-to-day decisions on its operations.
Team“D” will analysis Guillermo’s alternatives and make a recommendation on which alternative will enhance the businesses financial decision. Maintain Current Operational Levels One option available to Guillermo is to make no adjustments to the company’s current operations. This option supports the top concerns of acquisition from a larger firm and spending a large amount of cash on high-tech equipment investments, it does not solve the problem of a shrinking profit margin because of a rise in labor costs.
Supporting the option to maintain current operations overlooks potential opportunities that are identified to allow the company to move away from its primary manufacturing role and act as a distributor for the Norwegian competitor. According to the assets, liabilities, and equity information provided by the University of Phoenix, sales growth is slowing to 1% from previous periods. These low profit margins willnot sustain Guillermo in the long-term;they will not improve if there is not a choicemade to adjust to the financial situation. Maintaining current operations does not address the shrinking profit margins.
To continue to move Guillermo furniture in a positive direction, Mr. Navallez needs to apply some options already available and within the current operating structure. One option available to Guillermo is expanding the patented flame retardant process already in use within the manufacturing process, by applying a similar coating. This option requires no additional investment because Guillermo owns the equipment as part of the existing manufacturing process. The new coating adds value to the furniture, and makes it more appealing to consumers (University of Phoenix, 2009).
The net present value of the project must be calculated in order todetermine ifthis is a strong option. For planning and budgeting purposes, a three-year life cycle is assumed for the coating project with an initial investment cost of $222,705 that is absorbed during the first year of the project. This produces a projected cash flow of $1,733,562, leaving Guillermo with a net income profit of $42,557. Net present value for the three-year project calculates to $197,171. Another option available and immediately implemented is to reduce inventory by quickly turning over products, thus increasing the cash flow.
Planning an accurate budget supports the inventory overhead by reducing costs associated with maintaining inventory. The flex budget data shows that Guillermo furniture underestimated June operating expenses by $101,740. If these costs estimates were more closely tied to production costs, a substantial amount of cash would have been available to reinvest in other areas of the business. Closely managing this inventory will make more cash available for expansion in other areas of the company. Last year Guillermo experienced a $3,671 increase in its year-end inventory.
Keeping a large amount of inventory on hand ties up cash, which otherwise can be investedin other areas of the business. Guillermo’s option to hold fast and maintain current course is setting the conditions for failure. However, to maintain its current course and improve its financial standing, Mr. Navallez can leverage small opportunities that maximize the financial condition by leveraging the existing patent and reducing inventory. High Tech Business Upgrade Guillermo’s high tech alternative is based off a process currently being used by one of the Norwegian competitors.
It will allow the business to increase productivity but will also require a more skilled worker to operate the machinery. In choosing this alternative it predicts that sales will increase by 50% bringing in an increased revenue stream (University of Phoenix, 2009). In assessing this alternative looking at the net present value of future cash flows will help make this decision an easier one by noting the value it brings to the organization. Assuming that Guillermo expects to see a return on the investment within three years, this time period will be used in calculating the NPV.
Using the three year time period with an interest rate of 7. 5% and a growth rate of sales at 1. 0403% the NPV can be calculated at $617,178. The firm’s predictions on projected sales has not been the most accurate when looking at historical information. Conducting a sensitivity analysis will further help to determine the value of this alternative using the net income as the adjusted variable. Assuming there will be a best, worst, and most likely outcome to future sales revenue, the projected sales number of $195,564 will act as the most likely outcome.
By increasing this number by 10% and decreasing it by 10%, the best case and worst case scenarios can also be calculated respectively. These numbers will show how sensitive the NPV calculations are to the changes in net income. Under the best circumstances high tech alternative yields a net income of $215. 120 while the worst yields $176,008. These numbers translate into net present values of $617,486 under the best circumstances and $616,870 under the worse circumstances. If Guillermo decides to use the alternative funding for the expensive machinery becomes an issue.
There are three main ways in which to fund the purchase of this equipment and the additional cost of employee labor. The additional costs can be self-funded if the available cash is available. This will increase the equity in the firm but this will also reduce the leverage the company currently enjoys. The company’s equity can be used to purchase the equipment. This will have the same effect as if Guillermo used personal funds since he is the sole owner of the furniture company. The equipment can be financed through secured debt financing which will increase leverage as well as provide additional tax benefits to the organization.
And lastly, Guillermo can lease the equipment. Each of these alternatives provides unique tax benefits as well as pros and cons specific to each of these options. As Guillermo considers this alternative in comparison to other options the cost of maintenance, salvage costs, depreciation costs, and increased labor costs should be factored. These all impact the overall capital budgeting decision faced by Guillermo Furniture. Distribution/Broker Opportunities Guillermo’s second alternative is to become a broker for one of the Norwegian competitors.
The company has been looking for channels to distribute in North America as it has chosen not to operate furniture outlets but instead to rely solely on chain distribution (University of Phoenix, 2009). Guillermo’s existing business relationships afford him the opportunity to coordinate a distributor network that generates a new form of revenue for the company. This new stream of income can help offset some of the financial challenges that have emerged as a result of a competitive furniture market and increasing costs.
In addition to becoming a broker, Guillermo can also continue offering some of his high end custom products. To determine if becoming a broker is the best option, Guillermo will evaluate the NPV and WACC for the proposed project. To calculate the NPV, Guillermo must consider the investment time period and the discount rate. In this case, Guillermo will review a period of 20 years. When calculating, the need to remove the income tax from the net profit and then re-add the depreciation back in. Next, consider the value of the company’s equipment.
For the purpose of this paper, it will be assumed at $100,000,000 with a straight-lined depreciation of $100,000 yearly, over a 10 year period. Once the ten years is complete, the before tax income will increase for the broker option by $100,000. The cash flow will be reduced by 42% since Guillermo will have to pay the taxes on the increase. Since the building will be completely depreciated after 17 years, the net income before taxes will be $50,000. The net present value for the broker option over the 20 year period at 10% will be $4,125,109. 02.
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