Can someone help me with this homework from Fin 571. I am interested in two alternatives. At least maybe 300 words a piece. Or whatever seems fair. This will be taken to a plagiarism site at the school so I need any references used. ASAP. I work a lot but I will keep checking for a finished product.
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Can someone help me with this homework from Fin 571. I am interested in two alternatives. At least maybe 300 words a piece. Or whatever seems fair. This will be taken to a plagiarism site at the school so I need any references used. ASAP. I work a lot but I will keep checking for a finished product. Resources: The Guillermo Furniture Store Scenario. Write a paper in no more than 2,100 words that analyzes Guillermo’s alternatives and make a recommendation of a financial decision. The paper must also include a justification for your recommendation. Format your paper according to APA standards. My previous paper was; It was never check so I don’t know how good it is Running header: Guillermo’s Furniture Guillermo’s Furniture Store Scenario Guillermo’s furniture store located in North America is owned by Guillermo Navallez. He has been in business for many years and business was great until the late 1990’s came and helped him face reality. Others were interested in making chair and tables also. Faced with heightened competition and a weak economy, Guillermo may be faced with becoming a distributor instead of manufacturer. Guillermo wants research done on his company for possible solutions of making the store more profitable. This paper will examine, WACC, multiple valuation techniques in reducing risks, and calculate NPV of future cash flows. Weighted Average Cost of Capital The weighted-average cost of capital is the rate of return that the firm must expect to earn on its average risk investments in order to provide a fair expected return to all its security holders. We use it to value new assets that have the same risk as the old ones and that support the same ratio of debt. The weighted-average cost of capital is an appropriate discount rate only for a project that is a carbon copy of a firms existing business. This paper will examine, WACC, multiple valuation techniques in reducing risks, calculate NPV of future cash flows. . Most companies are financed by a mixture of securities, including common stock, bonds and often preferred stock or other securities. Each of these securities has different risks and therefore investors in them look for different rates of return. In these circumstances, the company cost of capital is no longer the same as the expected return on the common stock. It depends on the expected return from all the securities that the company has issued. It also depends on taxes, because interest payments made by a corporation are tax-deductible expenses. Guillermo’s cost of capital will be calculated as a weighted average of the after-tax interest cost of debt financing and the “cost of equity,” that is, the expected rate of return on the firm’s common stock. The weights are the fractions of debt and equity in the firm’s capital structure, weighted-average cost of capital. The weighted-average cost of capital to evaluate average-risk capital investment projects. Meaning that the projects risk matches the risk of the firms existing assets and operations. As we know that, the weighted average cost of capital is: WACC=Kd * 1-T * Wd + Ke * We This is defined as: Kd Cost of debt before tax 7.5% T Tax rate 42% Wd Weight of debt in the capital structure 84.3% 82.4% Ke Cost of equity 11.34 We Weight of equity in the capital structure 15.7 17.5 Weight of Debt: Information from Assets, Liabilities & Equity Information Wd 2007= Total liability/ Total Equity=$1,130,963/$211,111+$1,130,963= 84.3% Wd 2008=Total liability /Total Equity=$1,109,358/$235,805+$1,109,358= 82.4% Cost of equity: Risk free rate=4.36% Market rate of return (S&P)=13.08% (source: standardandpoors.com) The contribution of a security to the risk of a diversified portfolio depends on its market risk. But not all securities are equally affected by the up and downs in the market. The sensitivity of a stock to market movement is known a beta. Stocks with a beta greater than 1.0 are particularly sensitive to the market. Beta for Guillermo’s project will equal (=0.8). Cost of equity, Ke=4.36%+(13.08%-4.36%)*0.8 Ke=4.36% + (8.72%) * 0.80 Ke=4.36% + 6.976% Ke=11.34 % Weight of Equity: Wd 2007=total liability total Equity + total liability=$211,111/$211,111 + $1,130,963=15.7% Wd 2008=total liability total Equity + total liability=$235,805/$235,805 + $1,109,358=17.5% Final answer for Guillermo’s WACC is, WACC 2007=7.5%*1-42%*84.3%+11.34%*15.7%=5.54% WACC 2008=7.5%*1-42%*82.4%+11.34%*17.5%=5.57% Discuss the use of multiple valuation techniques in reducing risks. There are a number of valuation techniques that help reduce risk. One is called the “Discounted Cash Flow Valuation.” Answers (2008), it is a valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one. Calculated as: This valuation is a pertinent tool for getting the value of an asset but it has some disadvantages. For one it is not really possible to find the exact value of ones cash flow in the future especially in our times and it may take many trials and errors to come up with the best discount rate. The second valuation technique I’ve chosen to discuss is “Relative Valuation.” Wikipedia (2008), relative valuation is a generic term that refers to the notion of comparing the price of an asset to the market value of similar assets. In the field of securities investment, the idea has led to important practical tools, which could presumably spot pricing anomalies. These tools have subsequently become instrumental in enabling analysts and investors to make vital decisions on asset allocation. My final valuation technique is called the “Contingent Claim Valuation.” This technique values the stock based on the fact that the value of the asset may be greater than the present value of the expected cash flow if the cash flow is contingent on the occurrence or non occurrence of an event. A disadvantage of using this technique is its use of discounted cash flow may underestimate the value of the asset. Calculate NPV of future cash flows for each of the alternatives. Hi-Tech Broker 416,667 416,666.67 Extra depreciation for hi-tech and broker 100,000.00 100,000.00 Assumed Depreciation for equipment 316,667 316,667 Assumed Depreciation for Buildings 1,000,000 1,000,000 Assumed Investment in equipment 9,500,010 9,500,010 Assumed investment in Buildings 10,500,010 10,500,010 Total extra investment 1,050,001 1,050,001 Cost of investment at 10% 88,732.65 4,859.41 Extra gain from investment (0.92) (1.00) Return from investment both negative Pro Forma Cash Flow Budget For The Year Ended 31 December 2009 &nb sp; Inflow Outflow Inflow Outflow Inflow Outflow Inflow Outflow Inflow Outflow Year 1 Year 1 Year 2 Year 2 Year 3 Year 3 Year 4 Year 4 Year 5 Year 5 $ $ Net cash inflow from operating activities (depreciation is added back to net income before taxes 92,577 &nbs p;96834.7 101518.2 106669.987 112336.9857 Returns on investments and servicing of finance &nb sp; Interest rec eived Interest paid ; Dividends paid &n bsp; 10000 12000 14000 16000 Net cash inflow/ (outflow) from returns on investments and servicing of finance &nb sp; Taxation &nb sp; Corporation tax paid ; Tax paid ; Total Tax Paid 17,882 &nbs p; 19670.57 21637.63 23801.39454 26181.53399 Payments to acquire intangible fixed assets & nbsp; Payments to acquire tangible fixed assets & nbsp; Receipts from sales of tangible fixed assets & nbsp; Net cash inflow/ (outflow) from investing activities X or (X) & nbsp; Net cash inflow before financing &nbs p; Financing & nbsp; Issue of ordinary capital & nbsp; Repurchase of debenture loan (X) &nbs p; Expenses paid in connection with share issues (X) &n bsp; Net cash inflow/ (outflow) from financing X or (X) & nbsp; Increase/ (Decrease) in cash and cash equivalents 74,695 X 67164.13 67880.54 68868.59246 70155.45171 In conclusion firms compute weighted-average costs of capital because they need a standard discount rate for average-risk projects. An average-risk project is one that has the same risk as the firm’s existing assets and operations. And if the projects are not averaged then the weighted-average cost of capital can still be a benchmark. The benchmark is adjusted up for unusually risky projects and down for unusually safe ones. We can analyze Guillermo's alternatives by finding out the return on investment that Guillermo makes in the two alternatives namely hi-tech and broker. It is evident from the depreciation figures that additional buildings and equipment have to be purchased. The depreciation figures for own business is first reduced from the depreciation figures. From the depreciation figure of $416, 667 we assume that $100,000 is for equipment. This means that $100,000 X 10 = $1 million is the cost of equipment. Similarly, the cost of building can be calculated as 316,667 X 30= 9,500, 010. If we assume the cost of investment to be 10% ( if a bank loan is taken the interest rate may be higher). The cost of investment is 1,050.001. The extra gain from high tech option is $88,732 and the extra gain from broker is $4,858. In each case there is a negative return from investment. It is recommended that Guillermo should continue with the current business. The reason for this is that additional investment in buildings and equipment is re he pro forma cash flow budget has been created for the current business. In the pro forma it has been assumed that the net income before taxes of Guillermo will increase by 10 percent every year. The depreciation remains the same as the building is written off over a period of next seventeen years. It is assumed that the applicable tax rate will remain 42%. Further, it is expected that Guillermo will withdraw either as dividends or as drawings an amount of $10,000 in the second year, $12,000 in the third year, $14,000 in the fourth year and $16, 000 in the fifth year. There are several other assumptions made. It is assumed that Guillermo will not acquire any further fixed, intangible or tangible assets. Also it is assumed that Guillermo will not involve itself in any investing activity nor will it issue any further capital. References Brealey, R. A., Myers, S.C. & Marcus, A. J, ( 2001). Fundamental of Corporate Finance, 3rd Edition, McGraw-Hill Primis CO, Inc. Kieso, D. E., & Weygandt, J.J. (1998). Intermediate Accounting, Volume 1, 9th Edition John Weiley & Sons, Inc, Emery, D. R., Finnerty, J. D. & Stowe, J. D, (2007). Corporate Financial Management, Third Edition, Prentice Hall: Pearson Education. http://www.answers.com/topic/discounted-cash-flow http://en.wikipedia.org/wiki/Relative_valuation Guillermo’s Furniture Store Scenario 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. Setup Information <Insert Facilitator's Name> 0.06 Peso? (1=Yes) 0 1.00 10.814 Mexican Pesos = 1.000 US Dollars Income Information-Current Standards Current Hi-Tech Broker Production Current Production = Sales Forecast Mid-Grade 2,532.00 3,798.00 3,798.00 Production can be increased by 50% and the broker also anticipates that same level High-End 506.00 759.00 759.00 Production can be increased by 50% Direct Materials ($)/Unit Mid-Grade 140.00 140.00 There are no material costs for brokered units High-End 250.00 250.00 250.00 Direct Labor ($/HR)/Unit 15.00 40.00 40.00 The labor rate is increased due to the technical skill level of operators Labor Time (Hrs)/Unit Mid-Grade 20.00 4.00 There are no labor times for brokered units and production times are 20% of original times High-End 30.00 4.00 4.00 Production times are now equal to the mid-grade level Direct Cost/Unit Mid-Grade 440.00 300.00 360.00 The Broker cost for Mid-Grade is based on net FOB destination including shipping/tariffs High-End 700.00 410.00 410.00 Price/Unit Mid-Grade 509.00 459.00 459.00 Prices are reduced by 10% because supply is increased High-End 879.00 789.00 789.00 Prices are reduced by 10% because supply is increased Plant Overhead/Yr Salaries 50,000 95,000 95,000 Need to add a 45,000 a year maintenance position for the equipment Utilities 9,000 27,000 4,497 Utilities are expected to be 3 x's current at full production (150% above current levels) based on units produced Benefits 103,730 82,412 21,644 Benefits are 10% of all wages (including direct labor) Insurance 3,000 15,000 15,000 Insurance will increase by 12,000 with the addition of the equipment and building expansion Property Taxes 975 3,900 3,900 Property taxes are 6.5%, assessment is 1% of original value, and that is on all plant/equipment Depreciation 50,000 466,667 466,667 Buildings are at 30 years and Equipment is at 10 years, straight line Supplies 6,000 6,000 6,000 Supply expense is miscellaneous and does not vary Income Tax Expense 17,882 82,137 21,401 Taxes are 42% of Net Income 265,282 891,543 663,663 Net Margins 222,705 695,979 612,708 Overhead 42,577 195,564 50,955 Net Income before taxes