For Guillermo Furniture Store, the analysis of the break-even point provides the amount at which the total fixed cost is the same as the total contribution margin. A difference occurs between revenue and variable cost. The Guillermo’s production units are 1,885 and 377 for mid-point and high-end respectively. Guillermo has to decide which of the three options that he has to provide a solution to the situation the company is facing at present. In making the decision, Mr. Guillermo has to put into consideration the extra costs and their benefits. The decision making process involves opportunity cost, which would indicate the differences between option value and the best value offered by one of the three options, which are investing in technology, turn into a broker for a Norwegian company and use its channels of distribution for the foreign company but giving up production of its own brand of furniture in the process, and the last option is to continue production the same way it has always done but enhancing quality of the finished products by using its newly developed technique of coating the products, which is patented.
A technique devised to determine the viability of a project is the Net Present Value (NPV)/Internal Rate of Return (IRR) analysis. The net present value is calculated in relation to the anticipated returns from business ventures that also include the anticipated costs used to organize the project. The return and expense in NPV are rate discounted that shows opportunity cost and inflation. In a situation like this one, discounting the cash flow at K1, this leads to positive NPV. IRR > K1 means the project is acceptable. In contrast; discounting the cash flow at K2 makes NPV negative and K2> IRR means the project is unacceptable and should be rejected. Net present value sensitivity is figured to an opening venture of $300,000 for hi-tech, current, and broker options by looking at the sensitivity analysis, the cash flow cumulative the conclusion of year one is the addition of -$300,000 and $39,061, which would give -$260,939 in which case present value is $39,061 of $42,577 annual return computed by considering 6.38% discount rate, which has the same value as weighted-average cost of capital.
On the basis of this analysis, only the option of acquiring hi-tech machineries has relevance to Guillermo and is the suggested project for the company in the specified circumstances. The company has to react to competition and by acquiring the high-tech machine, the cost of labor would be reduced and profit will be increased.
References
University of Phoenix (2010).University of Phoenix Material: Guillermo Furniture Store Scenario. Retrieved October 11, 2010 from: University of Phoenix website, Course Materials, FIN571
