While many people know that Sonora, Mexico is a beautiful vacation spot, it is also a large furniture manufacturing location in North America. Guillermo Navallez made furniture for years near his Sonoran home. The area had a good supply of timber for the variety of tables and chairs produced by his company. Labor was also relatively inexpensive. In addition, he priced his handcrafted products at a slight premium for the quality they represented. Overall, life was good for Guillermo.
All of that was true until late in the 1990s when two forces combined to cause a large dent in his business. First, a new competitor from overseas entered the furniture market. Using a high-tech approach, this foreign competition provided furniture to exact specifications and did so with rock-bottom prices. Second, the sleepy communities in Sonora woke up. One of the largest retailers in the nation's headquarters was just a few miles down the road, and its influence had expanded considerably. With inexpensive housing, mild weather, beautiful scenery, un-congested roads, a new International Airport, and plenty of development, an influx of people and jobs raised the cost of labor substantially. Guillermo watched his profit margins shrink as prices fell and costs rose.
After doing some research on his competition to see how they are handling these changes, it is clear that many of them are consolidating into larger organizations by merger or acquisition. Being independent, Guillermo does not relish the idea of being acquired by a larger competitor and then retired as the new company squeezes every peso it could out of the overhead costs. Guillermo also is not looking to expand his management responsibilities by acquiring another organization either; that could affect his time with his family in ways that he will not enjoy.
Guillermo then spent some time looking at the foreign competition and their high-tech solution. Essentially, their production utilizes a computer controlled laser lathe to produce exact cuts in the wood. Highly automated, the plant in Norway uses very little labor as robots even perform the precise movement and assembly functions. The cost of the technology is immense, as is the reduction in the labor needed for production. In addition, the production can move between products quickly, and it runs on a 24-hour basis, as the shift-differentials are more than offset by the reduction in labor. Converting his production to this model would be expensive, but he saw how he could also decrease dramatically his production costs.
When talking to some of his distributors about their wants, he had another idea that appealed to him. A second competitor, currently operating only in Norway, has been looking for channels to distribute in North America. This second potential rival, however, did not operate furniture outlets favoring instead to rely on chain distributors. Perhaps Guillermo could coordinate his existing distributor network and essentially become a representative for this other manufacturer. While he may retain some of the high end custom work, he could move his company from primarily manufacturing to primarily distribution.
Guillermo also has a patented process for creating a coating for his furniture. In producing this product, the process first creates a common flame-retardant, and upon further processing, the coating is complete and stain resistant. There is market for the flame retardant, but not as much of a market for the finished coating. There is another product that Guillermo could buy to apply to his furniture as well that would add the same amount of value for the furniture.
Assignment from Professor:
Greetings Class:
In Week One after reading the Guillermo Furniture Store scenario you identified some finance concepts taken from the Week One chapter readings that were applicable to Guillermo Furniture Store. In Week Four each student is performing an analysis of the company's finances and the capital structure of the store. In both Week Four and Six the Excel file that contains the financial statements of the company are used and in Cell A3, where they have the facilitator name you must paste my name as it appears below in this cell (only my name without the MSF). The pasting of my name in this cell will change the numbers as this is an interactive Excel file.
The Guillermo Store Analysis paper should include a sensitivity analysis, determination of Guillermo's optimal weighted average cost of capital, discussion on the use of multiple valuation techniques in reducing risks and the net present value of future cash flows for each alternative. I have attached an Excel File template that will assist you in arriving at the various alternatives that Guillermo should consider.
Assignment:
- Analysis of different alternatives available to Guillermo, included sensitivity analysis
- Determination of optimal WACC
- Use of multiple valuation techniques
- NPV of future cash flows for each alternative
Assumption Excel File
- In the Excel file provided, which is based on "assumptions" it outlines the different alternatives that Guillermo can consider. In Scenario One number six you are told the capital expenditure is an initial $7,000,000 and an additional cash outlay of $700,000 in years two, four and in year five. This cash outlay is based on them increasing technology, but this amount does not need to be used as this is an assumption. It is not about the numbers, but based on what amount you used what would be the NPV and IRR. Based on the NPV and IRR you are deciding whether this would be a good decision for Guillermo to purse.
- Scenario Two and Three the Capital Expenditure amount given can be used or changed as these are assumption numbers. Since you have the Capital Expenditures for each scenario the next step is to compute the cash flows in Year One through Five. When a project has net cash outflows in the project life as in year two, four and five these have to be accounted for in your NPV and IRR calculations.
- The budgeted and actual numbers provided in the scenario will be used in each tab's Revenue and Expenses.
- Scenario Three Guillermo is considering selling flame retardant as an additional product as there is a market for this product. If he decides to sell this product based on Scenario Three then he will have to add additional capital equipment costing $500,000 in Year 0 and an additional $50,000 in year two, four and five. Based on this alternative then the company will continue to sell furniture, but now sell the flame retardant as additional source of revenue. The information for Scenario Three is based on the Production for March given in the data.
- The initial investments are keyed into each tab's D45 under Year 0, the additional cash outflows are keyed into tab's F45, H45 and I45 for each tab.
- The numbers provided for Guillermo Furniture should be used as given as I stated there are errors. It is not the numbers, but how you analyze and interpret the numbers provided and arrived at on the Excel template file provided.
- There is no right or wrong answers for the assignment and all students will arrive at different solutions. The key to focus on is how you are able to analyze the information presented while making assumptions for the missing data that the company does not know about. In your paper I am looking at how your present this information to Guillermo as you are giving the client options and alternatives to evaluate in the next two to five years.
- The sensitivity analysis part of the assignment is based on the assumption that student's were familiar with this concept and how it is utilized in the corporate world. This topic is not covered until Week Six, Chapter Eleven on page 303 - 307, therefore read this section and review the problems I have illustrated below from the section on sensitivity analysis. I am going to provide the answers to Problems B1 that covers Sensitivity Analysis.
B1. (Excel: Sensitivity analysis) The project has expected sales of 1,000 units, price of $500 per unit, cash operating expenses of $200 per unit, straight-line depreciation to zero over a 10-year life, a cost of capital of 10%, investment of $100,000 and tax rate of 40%.
a. What is the project's NPV?
b. Calculate the effect on NPV of each of the following changes: Sales are 1,100 units; cost of capital is 11%; initial outlay of $110,000; tax rate of 45%. assume other values are as expected.