Guillermo Furniture Store Proforma Analysis

The issues driving these analysis decisions are the facts that a company located in Sonora Mexico relying on inexpensive labor conditions threatened from third party competition. This in of itself is driving up labor costs. The analysis took in the concept of increasing NPV to its highest levels where the broker distributorship is the ranking of choice in the decision to move forward. Guillermo’s Furniture Store ProForma Analysis In a sleepy little town on Sonora Mexico, Guillermo Furniture being two years old is at a decision step to take on additional productivity as the international competitive pressures build up.

The pro-forma cash flow analysis will look at three functions, with no change to the current operation, furniture based high tech company, and the company as furniture based distributor/broker. Even though following the financial principles to perfection, properly run Guillermo Furniture organization achieves profitability because of looking to analysis that sees a decision based on the status quo, innovating to a High-Tech production, or to a distributorship.

The tree levels of analysis include a corporate weighted average cost control analysis (WACC), a net present value analysis (NPV), and a complete ProForma analysis where all the areas relevant to the company achieving its daily goals are computed and shown in the attached forms in tables one through three. Additionally, a weighted average cost of capital analysis will give a lower rating to decrease risk. Lastly an analysis that looks at probable maximum loss (PML) as a function of NPV, the risk can be pportioned to an internal rate of return (IRR) being greater than WACC and seeking to outpace PML. Maquiladoras American labor infusions into Sonora area of Mexico are driving the costs of labor up. Authors found that “…. we analyze the impact of the Corporate Flat Rate Tax on a Maquiladora or manufacturing company in Mexico. The results show no impact on liquidity due to this new tax” (Cisneros, Teran, Lopez, Carriolo, 2012, p1). With this, a conclusion infers that the flat tax rate creates an infusion into the Mexican corridor as corporate rates are important.

However Guillermo Furniture has a high tax rate compared to American counterparts and a higher rate than the rest of the world. A move to an area such as the Maquiladoras and enjoying favorable tax status will create an even better outcome even in light of the labor costs increasing. Commissioning this move, the following analysis makes the case for one decision tree. Status Quo Navallez faces tough financial decision to make. It looks like the store owner and its board of directors may want to make some adjustment if they want to continue making money or stay in business.

The biggest obstacle the owner faces is to overcome the self-interested behavior (Emery, Finnerty, ; Stowe, 2007), and choose what is right for the business, especially with tough competitors. In general any company that has a monopoly in the city or neighborhood will impose its prices to its customers. Guillermo’s Furniture Store was not making the exception, we can quote what the scenario says,” he priced his handcrafted products at a slight premium for the quality they represented” (Guillermo’s Furniture Store Scenario, UOPX website, 2012).

Since Guillermo furniture store faces competition from rival furniture stores, Team A believes that he cannot he afford to continue doing the same thing and still be profitable. As Albert Einstein said,” you can’t continue to do the same thing over and over and expect different result”. He has definitely enjoyed his free ride but the time is in the past. His competitors are using a high-tech approach, good quality products, and their prices are cheaper than what Guillermo is currently charging. If Guillermo chooses to remain independent, he will have to sacrifice its shareholders who invested in his company.

A merger can help his business with more resources including human management, equipment, and, reduction in labor. Guillermo furniture financial report shows that the labor for high-tech and broker is increasing due to the technical skill level of operators. An investment on new efficient equipment like those of his competitors will help reduce this issue. Maintenance of current equipment is high on high tech and broker. Net Income before tax on all three product shows that high-tech is five times more profitable than Current and Broker.

The best alternative to be used by Guillermo furniture store depend on capital budgeting decision strategies of the three alternatives mentioned and see which one will result in a positive net present value (NPV), calculate the weighted average cost of capital (WACC), and internal rate of return (IRR) of the alternatives. The WACC (Weighted average cost of capital) can be expressed as the weighted average of the required return for equity( re) and the required return for debt, (rd)” (Emery, Finnerty, & Stowe, 2007, p. 198). The WACC shows how much Guillermo is borrowing in a project to determine whether the company will be profitable or not.

Calculating the WACC based on data collected from Guillermo balance sheet and Income Statement Return /Debt15% Return/Equity71% Tax /NIBT42% Debt/ ( Debt & Equity)82% Equity/ (Debt & Equity)18% WACC19. 19% WACC= (1-L)re+L(1-T)rd, WACC= (1-. 82). 71+. 82(1-. 42). 15= 0. 1919 = 19. 19% The data above was found from Guillermo Balance sheet and income statement. This WACC seems too high, if the company initiates a new project it will be hard to make money because they are already borrowing more money. It will be hard to make any return on investment, which is higher than current WACC.

Let’s assume that Navallez decides to borrow 4,000,000 to invest in his business, at an interest rate of 8% and expected rate of return of 12 %. What will be the net present value of his investment? “Net Present value (NPV) is the difference between what something is worth (the present value of its expected future cash flows-its market value) and what it costs” (Emery, Finnerty, & Stowe, 2007, p 222). The NPV formula is NPV= CFo+CF1/(1+r)+CFn/(1+r)n . If Guillermo wants to borrow that amount, can he make money? FV after one year of that amount would be 4,320,000 so looking at how much he earned, NPV=-4,000,000(1. 8)^-0 + 4,320,000(1. 08)^-1, NPV = 0, It shows that he will not make enough on the first year. Meanwhile, his competitor will be making money, so investing money in a short term may not be a quick solution when the competitor are already at the door attacking his profit. The Internal rate of return (IRR) is another method of evaluating a capital budgeting project. Navallez may have difficulties securing a loan at a cheap interest rate; looking at his balance sheet the store has borrowed 82% of the total asset. Only 18 % of the total asset is financed from his equity.

If he gets a loan with high interest rate while trying to lower prices, due to competition, he may not make enough money, either. It is clear that doing nothing when a clear danger is facing the firm may throw him out of the business. He enjoyed making money while he was alone with fewer competitors but at this point he faces challenges and he is squeezed by his competitors. The Status quo definitely is not an option to utilize at this point. High Technology Mr. Navallez must evaluate carefully the capital budgeting tools to create the most value for his organization stakeholders.

Recall that “a net present value (NPV) is 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 = Present Value (PV) of the Cash Flows discounted Using the computations from the WACC it is calculated the he has a negative NPV, thereby, not giving him a very high IRR. NPV = ($197,125. 18) IRR = 10. 02% “In a perfect capital market, a firm’s capital structure has no effect on its value. A firm’s value is based entirely on the profitability of its assets and the expected NPVs of its future projects” (Emery, et al. 2007, p. 464). Mr. Navallez, being a seasoned veteran within the furniture business, gives him a comparative advantage according to the principles of finance. The personal knowledge of the business along with his financial data allows him to make an informed assessment of his options. Guillermo is very conscious technology saves time and money, long term; however, short term, it is a very costly endeavor requiring a large amount of capital to bring to fruition. Nonetheless, he is also very aware that there is a trade-off between risk and return. Distributor

Considering all options to turn the business around, Guillermo Furniture Store looks to assist as a distributor/broker the Norway competitor in entering into the North American furniture market (University of Phoenix, 2012). In considering becoming a distributor, being “an independent selling agent who has a contract to sell the products of a manufacturer,” GFS must look into several factors such as the “large initial investment” (USLegal, Inc. , 2012). Normally fees such as fees associated with starting up and ongoing fees exist. Most agreements are renewed annually for a minimum term of five years.

There are two financial equations considered when making this decision: weighted average cost of capital and net present value. Weighted average cost of capital refers to the understanding of required return and the risks involved in participating in them. For instance, in keeping with the status quo alternative, costs of equipment are rising, the margins of profit are becoming more competitive, and competition is becoming stronger. In the high technology option, the cost of updating and new equipment is outrageous in order to update the facility to match its competitors.

The distributor option allows Guillermo Furniture to capitalize on his special patented coating process, join his competition in Norway, and lower overhead costs. The net present value refers to the difference of what an asset costs versus what someone is willing to pay for it. The net present value for status quo is zero, high-technology is ($197,125. 18), and distributor is $803,023. 86. These three comparisons of the net present value make the decision easy for Guillermo Furniture Store. Pro forma financial statements reflect the firm’s decision on future financial statements.

These statements provide more detail of the units, resources, and the breakdown of responsibilities. Using these statements helps firms when there are unexpected situations which occur, such as this; changing the future of the Guillermo Furniture Store. Team A’s decision is the distributor. The distributor option by far is the reasonable outlook for this company. The weighted average cost of capital and net present value both agree with this decision. The efforts exerted in changing Guillermo’s Furniture Store to a broker and distributor will have tremendous payoffs in addition to more profit.