GUILLERMO FURNITURE STORE

Guillermo Furniture Store

Guillermo Furniture Store

Introduction

Guillermo Furniture Store has 3 possible choices such as they can evolve into broker or can make high- tech. They can break their project into current, high tech and broker. Guillermo's furniture store needs to select the option which is good for them and can provide competitive advantage to the store. It has been clear that managers are responsible for the use of capital budgeting techniques to find out exclusive project. We have different types of capital budgeting techniques.

“These capital budgeting techniques are:

Simple Payback, and

Discounted Payback

Net Present Value (NPV)

Internal Rate Of Return (IRR)

The simple payback period:

We can define the simple payback period as the expected number of years required to recover the original investment by Guillermo's Furniture Store” (Brown, et. al, (2006), i.e. how much time a company needs to compensate their investment, if their invested amount is 300 million dollars. Evaluating capital budget projects, payback period is the approved method. Here is the payback period for Guillermo's Furniture Store. The cumulative cash flow of Guillermo's Furniture store at t = 0 is just the initial cost of -$300,000. At Year 1 the cumulative cash flow is the previous cumulative of $300,000 plus the Year 1 cash flow of $500: -$300,000 + $42,573=-$257,427. Similarly, the cumulative for Year 2 is the previous cumulative of -$257,427 plus the Year 2 inflow of $42,573, resulting in -$214,854. We see that by the end of Year 7 the cumulative inflows have more than recovered the initial outflow. Thus, the payback occurred during the third year. If the $40,584 of inflows comes in evenly during Year 3, then the exact payback period can be found as follows:

Applying the same procedure to Project High-Tech and Broker, we find Payback period for them is 1.53 years and 5.89 years respectively. It is understandable that shorter payback period is better. We know that if the projects are mutually exclusive then High tech would be acceptable and current project would be rejected and High tech would rank higher over the other two projects because it has shorter payback period. Mutually exclusive project means that if one project is taken on, the other must be rejected (Brigham, 2004).

Discounted Payback Period:

“In the real world firms use a variant of the regular payback, the discounted payback period, which is similar to the regular payback period except that the expected cash flows are discounted by the project's cost of capital (WACC). So we can say that the discounted payback period uses the time value of money in its decision” (Brigham, 2004). Here, the discounted payback period is defined as the number of years required to recover the investment from discounted net cash flows generated from the project.

If we look at the values of discounted cash flows we can find that the discounted payback period for Current project is 9.9 years whereas High-Tech and Broker project 1.4 year and 8.1 years respectively

For Projects Current, High-Tech and Broker, project High-Tech ranked higher as compared to the ...