Guillermo furniture store Essay Example | Topics and Well Written Essays - 1500 words

Guillermo furniture store - Essay Example One of the options available to Guillermo in order to deal with the competition is to go high tech. However, one will have to consider whether there is a demand for these furniture that will make the use of robots feasible. As indicated in the case investing in robots and expanding the production facility is a very capital intensive exercise and therefore the volume required to make the project feasible is very important. Guillermo is currently producing 2,532 units of the Mid-Grade furniture and 506 units of the High-End furniture. If he goes hi-tech he can increase both by 50% to 3798 units of Mid-Grade and 759 units of High-End. Producing is one challenge but getting the items sold is another challenge. In order to determine whether this project is feasible a sensitivity analysis and an evaluation using net present value will be carried out. Sensitivity Analysis Sensitivity analysis performed using the information in the spreadsheet indicates that this project will not yield any p ositive returns (when combined with the current high-End operations) if production levels are not at least 14.2% above current levels. At 14.2% above current levels Guillermo would be producing 2892 units of Mid-Grade and 578 units of High-End furniture. See Appendix 1 for results. Broker Another option open to Guillermo is to become a distributor in North America for a Norwegian company. This project will involve an expansion in the facility to accommodate the increased production. It will also involve the use of robots. Sensitivity Analysis Sensitivity analysis using the information given in the excel spreadsheet indicates that Guillermo would not be able to yield any profits on being a Broker if the level of sales is not at least 38.3% above current production levels. See Appendix 1 for details. Therefore, this project will not be able to withstand any large fluctuations in demand. The Weighted Average Cost of Capital (WACC) The formula for calculating WACC is as follows: WACC = E/(D+E)re + D/(D+E) (1-T)rd = (1-L)re + L(1-T)rd Where, E is shareholders’ equity D is debt T is the tax rate L is leverage re is the cost of shareholders funds, for which ROE is used in this question ROE = (profit after tax/shareholders’ funds) x100% = 24,695/235805 x 100% = 10.5% rd is the cost of debt, for which the interest rate on the building financed 12 years ago is adjusted for a 3% per annum rate of inflation = 10..4% Leverage = D/(D + E) Leverage = 936,628/1,172,433 = 0.8 Therefore, L = 0.8 and (1-L) = 0.2 WACC = 0.2 x 10.5 + 0.8 + (1 – 0.42)10.4 = 2% + 5% = 7% This is the current WACC and is the lowest return expected. Therefore, it will be used to calculate the NPV Evaluation Techniques Emery et al (2007) states that: â€Å"when making capital budgeting decisions, a firm evaluates the expected future cash flows in relation to the required initial investment. The objective is to find investment projects that will add value to the firm.† The rol e of management is to analyze each option to determine which method would result in more profits and therefore yield more benefits for the company. There are a number of techniques available to determine which project is more feasible. These techniques include payback period, accounting rate of return (ARR), net present values (NPV) and internal rate of return (IRR). The two options available to Guillermo can be assessed using these techniques. Payback Period The payback period indicates the length of time that the project takes to recover the initial investment (Brigham and Ehrhardt, 2005). This method is biased towards short term projects. â€Å"Investments with longer payback periods are often more risky than those with shorter payback periods. This is because the shorter the payback period, the lower the risk that market conditions can render the initial inv