Guillermo Corporate Finance Examining Guillermo Furniture: The

Guillermo Corporate Finance Examining Guillermo Furniture: The Principles of Corporate Finance Guillermo Furniture, a furniture manufacturer, wholesaler, and retailer located in Sonora, Mexico is faced with a choice. The company is facing increasing competition from overseas competitors that employ newer technologies in the manufacturing process that allow them to reduce labor costs without significantly sacrificing the quality of their products.

With a rather substantial initial investment, Guillermo Furniture can purchase the equipment necessary for them to also move to a more automated manufacturing process, which would solve the problem of increasing labor costs in Sonora but which would also drastically change the company and its relationship with the people of the region. Guillermo could also shift from manufacturing to distribution, again drastically changing his company and his workforce relationship yet employing more individuals with lower initial costs.

An application of the principles of corporate finance to this case can help a decision to emerge. Applying the Principles The first primary principle that must be examined in this case is the investment principle, which is itself made up of several smaller principles. First and foremost is the concept of the "hurdle rate" -- however Guillermo proceeds, the expected return must be at this rate or higher, and the riskier a project is the higher the bar of the hurdle should be raised.

The major monetary investment to move to robotic/automated manufacturing increases the risk of this decision significantly, meaning there would need to be a high expected return to justify the expenditure. The hurdle rate and the overall investment principle is also impacted by the financing mix that will be used to fund whatever way forward is selected for the company.

There are essentially two sources of funding -- increased equity from the owners and borrowing from outside lenders (revenue from operations that goes to fund these projects is essentially owner's equity, as it would be going to the owner if it wasn't going back into the company).

The cash flows that will be generated from each project as well as the timing of these cash flows and the potential positive and negative side effects of the each choice must also be used to gauge the risk and hurdle rate for each project, and will help any company to invest wisely.

For Guillermo Furniture, the difference in expected cash flows from a move to distribution or a move to automated manufacturing must be examined; automating the manufacturing process requires a major outgoing cash flow though potentially more immediate revenue results, while distribution requires little initial investment but could take longer to pay off. Automation will also almost certainly require incurring major debt from an outside lender, while this could likely be avoided with a move to distribution.

The next "grand principle" in corporate finance is known as the financing principle, and it is closely related to some aspects of the investment principle. This principle states that projects should be funded in a way that maximizes the value of returns and matches the financing to the nature of the asset being financed. Borrowing is not always a bad thing, for instance; the fact that it will defer direct costs to the business for some time could be good for Guillermo's transitional period.

On the other hand, debt comes with interest payments, and though the short-term position Guillermo Furniture would be in after borrowing might be advantageous, if the revenue that came from moving to automation (the choice that would require substantial borrowing) wasn't substantially greater than revenue potential if the business continues operating as it currently does, it might not be worth it.

Also, borrowing creates a situation where the tangible assets of the business -- the machinery and plant modifications that will be necessary to achieve automated manufacturing -- will be essentially owned by the lender; equity financing keeps the owner in control and does not threaten operational capabilities even if revenue interruptions occur, whereas failing to make full payments on a debt could lead to equipment repossession or sell-offs that would quickly incapacitate the company.

The borrowing that would be required for Guillermo Furniture to move to automated manufacturing does not appear to be a good matching of financing to assets, in this light. The final major principle of corporate finance is the dividend principle, which essentially dictates how and when money should be returned to the owners of the company.

It is the goal of any for-profit company to make money for its owners, of course, and this money usually comes from projects originally or ultimately funded by the owners, thus the decision to fund new projects necessarily comes at the expense of returning money to the owners in the form of profit. If there are not enough projects that can earn the "hurdle rate," then, the money that would have funded such projects should go to the owner instead.

Selling Guillermo Furniture to a larger concern is definitely an option, though it is one that the current owner has decided against for personal reasons. This choice would constitute a full "dividend" payment, allowing the owner to "cash in" on his business rather than re-investing more.