Guillermo Furniture Store Recommendation The first alternative available to the struggling manufacturer involved the purchase of a computerized

lathe. This alternative will increase the speed and enhance the competiveness of Guillermos mid-grade line of furniture products. The introduction of the lathe in Guillermos operation provides increased accuracy and speed in the wood cutting process. This will allow Guillermo to reduce labor costs per unit and increase the companys efficiency in the manufacture of handmade premium furniture. The quantitative analysis done on this alternative required calculating the Net Present Value (NPV), the payback period and the Internal Rate of Return (IRR). The Net Present Value was selected based on its ability to show how effectively the project would generate sufficient incremental cash flow to service the debt of the organization. A project found to have a positive NPV is usually accepted as it reflects that the project will generate a positive cash flow. Utilizing data acquired from the financial statements, the purchase of the computerized lathe was found to have a NPV of $181,000. Given that the NPV is positive, the decision to purchase the computerized lathe should be accepted by Guillermo in terms of pursuing this as a viable option. The next quantitative method utilized the payback method to determine the time it will take investors to recover their initial cash flow. Guillermos furniture based on the payback method showed that the cash inflows exceeded the initial investment in a relative short amount of time and the payback period was calculated to be one-half years. Investors interpret this as a positive indicator that their investment will be repaid in a relative short amount of time and will also result in a profitable financial venture. The weighted average cost of capital (WACC) is defined as the costs of the components of a financing package that will allow the undertaking of a specific project (Emery, Finnerty, Stowe, 2007). Applying this definition to Guillermos Furniture Store the weighted average cost of capital was defined as the costs of the financing package that will allow Guillermo to undertake one of the available alternatives. Using data found in the case scenario, the calculation of Guillermos weighted average cost of capital (WACC) for the proposed alternatives was found to be 9.27%. Emery, Finnerty, and Stowe (2007) in The Financial Environment: Concepts and Principles state that it is important to understand, if capital structure is irrelevant a projects value cannot be affected by how it is financed thus WACC is constant for all values that affect cash flow. The Internal Rate of Return (IRR) was also selected to evaluate the expected rate of return as it relates to the weighted average cost of capital (WACC) and generates a surplus when the IRR is greater than the value of the WACC. Calculation of the IRR using the data associated with the purchase of the computerized lathe yielded a value of 10%. The analysis of the IRR allows Guillermo to establish if the expected rate of return (IRR) is greater than the required rate of return. Guillermos purchase of the computerized lathe revealed that the expected rate of return is greater than the required rate of return. Therefore, based on the quantitative analysis of the proposed alternative to purchase the computerized lathe it was determined that this option would allow the manufacturer the ability to improve cash flow and the companys financial position. Although quantitative methods play a large role in the decisionmaking process as it relates to capital budgets and major financial decisions, the use of qualitative

methods also can be useful. Qualitative methods involve the decision maker looking at the decision to purchase the lathe as a good fit in relation to the companys vision, goals, and overall competitiveness. Guillermo has expressed a desire to remain in the manufacturing business and wishes to keep pace with his foreign competitors. The introduction of the computer controlled lathe will also allow Guillermos Furniture Store to reduce their prices based on the savings they will receive from the reduction in labor costs. The reduction of labor costs and reduced prices will allow Guillermo to align with the rock bottom prices of his competition, which should result in winning back customers. Therefore, based on this desire and other concerns Guillermo will favor an approach such as the first alternative that allows him to remain in the manufacturing business. The second alternative investigated involved transforming the manufacturing operations from a manufacturing facility to a distributor of Norwegian products. This strategic move may prove to increase Guillermos incremental cash flow, profits, and allow the business going forward to remain successful. A qualitative analysis of this alternative reveals that this alternative involves transformation of the organizations manufacturing facility and would allow Guillermos Furniture Store to compete against other foreign furniture manufacturers, thereby preventing the need to acquire expensive high tech equipment. This alternative also transforms Guillermos Furniture Store into a supply chain distributor of the Norwegian furniture manufacturer and enables the Norwegians access to the North American market. The implementation of this alternative by Guillermo would give the company the ability to produce a very small amount of custom high end furniture products, but primarily would involve Guillermos Furniture store functioning as a distributor. This option eliminates Guillermos labor costs that are associated with the manufacture of the furniture products and eliminates the need to invest in the computer controlled lathe. The Net Present Value (NPV) of the second alternative, which involved transforming the business, was calculated as a positive value of $108,812. Further quantitative analysis of this alternative reflects the payback period would allow investors to recover their initial cash outflow in six years. The weighted average cost of capital (WACC) as stated in the earlier discussion involving the purchase of the computer controlled lathe, determined through calculations that the WACC of the second alternative was 9.27%. Using this to interpret the internal rate of return (IRR) it was found that the second alternative reflected an IRR of 15%, which required the company to transform from a manufacturing facility to a distributor facility. This option shows favorable quantitative data that would suggest it is a good fit for the company, but does not allow Guillermos Furniture to retain its primary manufacturing line of furniture products. Further research of the available options reveals that Guillermos Furniture has a third alternative available to increase the profitability and enhance the financial condition of the organization in the near future. Currently, Guillermo uses a patented process to coat the assembled furniture that involves the production of a flame retardant chemical product used in conjunction with a stain resistant final coating. The proposed third alternative suggests that Guillermo would purchase a pre-fabricated ready to use coating material that can be applied to the furniture following assembly. Utilization of this alternative would eliminate the costs associated with the expensive chemicals used in the creation of the patented coating that is currently applied to the assembled furniture products. A qualitative analysis of this option reveals that this alternative involves changing the process through the purchase of an

alternate coating that will add an equivalent amount of value to the furniture, as compared to the currently used material. Guillermo believes this is an option based on the lack of marketability of the stain resistant coating. This option would also allow the reduction of the labor costs to produce and apply the stain resistant final coating. The Net Present Value (NPV) of the third alternative, which involved eliminating the custom coating material, was calculated as a positive value of $735,142. Further quantitative analysis of this alternative reflects the payback period would allow investors to recover their initial cash outflow in three years. The weighted average cost of capital (WACC) as stated in the earlier discussions involving the purchase of the computer controlled lathe, and becoming a distributor determined through calculations that the WACC of the third alternative was 9.27%. Using this data to interpret the IRR it was found that the third alternative reflected an IRR of 45%, which required the company to eliminate the need to create a custom coating solution. Using the quantitative and qualitative techniques such as the NPV, the payback period, the WACC, and the IRR; Team A decided upon a final recommendation that would benefit Guillermos Furniture Store in the future. The recommendation of Team D involved Guillermo implementing a combination of the first and third alternative, which requires the purchase of the computer controlled lathe and elimination of the custom coating material applied to the product. The rationale surrounding the selection of the combination of these alternatives involved analysis of the results obtained using quantitative methods such as the payback period, NPV, WACC, and the IRR. This combination provides the greatest NPV and IRR, which shows the expected rate of return of these two options as they relate to the weighted average cost of capital and generates a surplus when the IRR is greater than the value of the WACC. The selection of the first and third alternative is supported through analysis of the payback period as it showed investors would recover their initial cash outflows in one-half years to three years. Among investors this is considered an acceptable period as it allows investors the ability to see quickly a return on the capital they have invested and allows them greater flexibility to invest in other projects. Qualitative analysis techniques revealed that Guillermo desired to continue manufacturing and keep pace with the output of the Norwegian Manufacturers. Guillermo also desired to win back customers that were previously lost to the foreign competition, which happened in large part because of the competitions low prices. Based on these desires it was shown that volatile changes in labor costs, and product prices played a large role in the selection of an effective recommendation. Various changes to the forecasted values of the furniture products were also factored into the selection of a useful method. Purchasing the computer controlled lathe and elimination of the custom coating material fits within the forward looking goal of Guillermos Furniture Store, which centers on the ability to offer a competitive product and increase profits. The owner Guillermo Navallez has expressed that he does not want to retire and does not wish to take on managerial duties. This wish contributes to the elimination of the second alternative, which involves Guillermos Furniture Store becoming a broker and essentially eliminating the majority of the manufacturing business. Working capital and capital budgeting decisions most often are based on the WACC and IRR as they focus on the cash flow versus profit. This is based on the difficulty of accounting for the variation in costs and prices, which are affected by economic conditions that are also difficult to forecast. Guillermos Furniture based on the recommendation to purchase the computer controlled lathe and modify its final coating from a patented process to an off

the shelf substitute, will achieve greater return on investments and generate a positive net present value. Investigation and research of Guillermos Furniture business also required the creation of a pro forma cash budget to fully understand the cash flows involved in this business. The pro forma cash budget is necessary as it will tell Guillermos Furniture Store if it will need additional cash to carry out business operations in the future. The pro forma cash budget accounts for the projected sales that will occur in the future based upon the recommendation to purchase the lathe and eliminate the patented coating. The pro forma cash flow budget also accounts for the revenues associated with the projected sales that will result from this decision. The pro forma cash budget will allow insight into the net income and projected profit as it subtracts the cost of goods sold from the projected sales. Using information from the pro forma cash budget will allow management at Guillermos Furniture Store to make better financial decisions regarding the future direction of the organization. The actual pro forma cash flow budget sheets can be found in the attached appendixes. In conclusion, businesses such as Guillermos Furniture Store must always research all available options as they relate to the working capital and capital budgeting decisions of their respective organizations. Investigation of the proposed options offered greater insight into the worthiness of the available options as they relate to the goals of the organization. It was essential that these financial decisions examined the quantitative data but also review the qualitative data as it relates to the fit of the businesses objectives. The quantitative and qualitative analysis techniques presented in this paper have highlighted the recommendation that will improve Guillermo Furniture Stores cash flow, sales, and overall financial condition. Implementation of a computer controlled lathe and the use of an off the shelf coating should show significant improvement of the companys growth and competiveness. Aggressive decisions by management such as those recommended within this paper are necessary to allow Guillermos Furniture organization to remain successful.

References Emery, D., Finnerty, J. & Stowe, J. (2007). Capital Budgeting., Corporate Financial Management., (3rd ed., pp 187 - 215). New Jersey, NJ: Pearson-Prentice Hall Emery, D., Finnerty, J. & Stowe, J. (2007). Business Investment Rules., Corporate Financial Management., (3rd ed., pp 216 - 243). New Jersey, NJ: Pearson-Prentice Hall. Emery, D., Finnerty, J. & Stowe, J. (2007). Capital Budgeting Cash Flows., Corporate Financial Management., (3rd ed., pp 244 - 276). New Jersey, NJ: Pearson-Prentice Hall. University of Phoenix (UOP). (2009). Week Six Web Link: Guillermos Furniture Store Scenario. Retrieved April 28, 2010, from University of Phoenix, Week Four, FIN/571 Corporate Finance Web site.

Appendix

Pro Forma Cash Flow Budget

(Using Alternative Number One Purchase Computer Lathe) | | | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | | | | | | | | 5615052 | 6176558

| Initial Year Revenue High-End | Mid-Grade | | |

| 4218672

| 4640539

| 5104593

| 17022996

| 18725296

| 20597825

| 22657608

| 24923368

Total Revenue | | | |

| 21241668

| 23365835

| 25702418

| 28272660

| 31099926

| |

| |

| |

| |

| | | | | 1512948 | 1664242

Cost of Goods Sold High-End | Mid-Grade | |

| 1136700

| 1250370

| 1375407

| 4757412

| 5233153

| 5756469

| 6332115

| 6965327

Total Cost of Good Sold | 8629569 | Net Revenue | | Labor Wages | |

| 5894112

| 6483523

| 7131876

| 7845063

| 15347556

| 16882312

| 18570543

| 20427597

| 22470357

| |

| | 11375464 | 12513011 | 13764312

| 12926664

| 10341331

Office Salaries | |

| 630000

| 648900

| 668367

| 688418

| 709071

Benefits | Supplies Utilities | Insurance

| 1355664

| 1084531

| 1192984

| 1312283

| 1443511

| |

| 71700 | 73851 | 76067 | 78349 | 80699 | | 109200 | 112476 | 115850 | 119326 | 122906

| 36000 | 37080 | 38192 | 39338 | 40518 | | 11700 | 12051 | 12413 | 12785 | 13168 | | | 15140928 | 12310220 | 13479337 | 14763509

Property Taxes |

Total Operating Expense | 16174185 | | | |

| | 5091205 | 5664088 |

Earning bef Tax & Depr | 6296172 | Depreciation | |

| 206628

| 4572091

| 600000

| 720000

| 864000

| 1036800

| 1244160

Earnings before Taxes | 5052012 | Income Taxes (42%) | Net Earnings | | | |

| -393372

| 3852091

| 4227205

| 4627288

|0

| 1617878

| 1775426

| 1943461

| 2121845

| -393372

| 2234213

| 2451779

| 2683827

| 2930167

| | 864000 | 1036800 |

Add back Depreciation | 1244160 | Subtract Capital Expenses 843570 | | | |

| 600000

| 720000

| 648900

| 713790

| 713790

| 778680

| | 2240423 | 2601989 | 2941947

TOTAL CASH FLOW | 3330757

| -7000000 |

| -442272

Appendix

Pro Forma Cash Flow Budget

(Using Alternative Number Three Off The Shelf Coating) | Initial Year Revenue High-End | Mid-Grade | | | | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | | | | | | | | 5615052 | 6176557.7

| 4218672

| 4640539

| 5104593

| 17022996

| 18725295

| 20597825

| 22657608

| 24923368

Total Revenue | | | |

| 21241668

| 23365835

| 25702418

| 28272660

| 31099926

| |

| |

| |

| |

| | | | 1512948 | 1664242.5

Cost of Goods | High-End | Mid-Grade | |

| 11136700

| 1250370

| 1375407

| 4757412

| 5233153

| 5756469

| 6332115

| 6965326.9

Total Cost of Goods 8629569.4 | Net Revenue | | Labor Wages | |

| 5894112

| 6483523

| 7131876

| 7845063

| 15347556

| 16882312

| 18570543

| 20427597

| 22470357

| |

| | 15641263 | 17205390 | 18925929

| 12926664

| 14219330

Office Salaries | | Benefits | |

| 630000

| 648900

| 668367

| 688418

| 709070.55

| 1355664

| 1491230

| 1640353

| 1804389

| 1984827.7

Supplies Utilities | Insurance

| |

| 71700 | 73851 | 76066.53 | 109200 | 112476

| 78348.53 | 115850.3

| 80698.98 | 119325.8

| | 122905.56

| 36000 | 37080 | 38192.4 | 11700 | 12051 | 12412.53 | | 15140928

| 39338.17 | 12784.91 | 16594919

| 40518.32 | 13168.45 | 18192506

| | | 19947994

Property Taxes |

Total Operating Expense | 21877118 | | | |

| | 287392.8 | 378037.1 | 479603.1

Earnings before Taxes & Depr | | 593238.45 | Depreciation | | | 600000

| 206628

| 630000

| 661500

| 694575

| 729303.75

Earnings before Taxes | 136065.3 | | | | |

| -393372

| -342607

| -283463

| -214972

|-

| |0

| |0

| |0

| |0 |0 | | -214972 | -136065.3

Income Taxes (42%) Net Earnings | |

| -393372

| -342607

| -283463

Add back Depreciation | 729303.75 |

| 600000

| 630000

| 661500

| 694575

Subtract Out Capital Expenses | | | | |

| 46330 | 50963 | 50963 | 55596 | 60229 | | | | | 160298 | 236429.8 | 327074.2

TOTAL CASH FLOW FOR ANALYSIS | 424007.1 | 533,009.45

| -500000 |