Tom Scott is the owner, president and primary salesperson for Scott Manufacturing. Because of this, the company's profits are driven by the amount of work Tom does. If he works 40 hours a week, the company's EBIT is $450,000 and if he works 50 hour weeks, company EBIT is $550,000 per year. Company is currently worth $2.7 million. Company needs a cash infusion of $1.5 million and it can issue equity or debt with an interest rate of 9%. Assume for this problem no corporate taxes.
a. What are the cash flows to Tom under each scenario?
B. Under which form of financing is Tom likely to work harder?
c. What specific new costs will occur with each form of financing?
Given two profit scenarios with different amounts of debt and equity financing, this solution discusses which will result in the greater cash flows, what costs are unique to each, and which will cause the owner to work harder to earn cash.
Guillermo Furniture Scenario: Capital Budget Recommendations
Guillermo Furniture, a company that manufactures mid-grade and high-end sofas, has just hired you as an accountant. The owner, Guillermo Navallez, has assigned you the tasks of determining which decisions provide the greatest returns. Review the Guillermo Furniture data sheets (attached).
The Guillermo Furniture Store Scenario:
Guillermo Navallaz is the proud owner of Guillermo?s Furniture Store located in Sonora, Mexico. He chose this area because of its excellent supply of timber for the variety of tables and chairs produced by his company. Business was going well until the late 1990s? when two events caused a decline in Guillermo?s business. First, a new overseas competitor entered the Sonora furniture market with their high-tech approach that provided furniture to exact customer specifications at low prices. The second event was that the community of Sonora began to grow. The increase of people and jobs raised the cost of labor significantly and Guillermo experienced shrinking profit margins as prices fell and costs rose (University of Phoenix, 2011).
In order for Guillermo to increase his profits, maintain his market share, and have an advantage over his competitors, he must look at alternative projects to improve business. The object of this paper is to make a recommendation for Guillermo to follow based on the financial analysis of the data presented and to evaluate three alternatives for Guillermo to consider. Once a course of action for Guillermo to follow is agreed upon, the team will analyze the financial data to support their recommendation, which will address the issue of foreign competition and labor cost.
The analysis will focus on how the alternative chosen will help Guillermo increase profits over the next five years and lower all the costs involved in producing or distributing the furniture. The paper includes a Cash Flow Budget, including assumptions, which will be based on the projected sales and expense budget for the year and any capital investments the company projects over the next five years.
- Obtain the number that is shown as a result for total assets on the assets, liabilities, and equity.
- Differentiate among the various capital budget evaluation techniques.
- Explain how these different techniques would help you make your recommendation to Guillermo.
- The cost of the asset is in the depreciation and please use 10% as the return rate. Recommend a course of action based on a capital budget evaluation technique and include present value calculations as part of your recommendation.