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By focusing measurement on cycle time, productivity, quality and profitability, Guillermo will have better information that can help guide his decision-making with respect to the different strategic choices with which he is faced. If he chooses to continue making furniture, he will be better equipped to improve his processes in the future as this information forms the basis of a much stronger control system than is currently utilized at Guillermo. For Guillermo, the best definition of investment is going to be the company's working capital. This is defined as current assets -- current liabilities. The returns are the net income. Thus, ROI is as follows:
Break-Even Analysis
The markets for the retardant and the coating have not yet been established. Guillermo has cost figures but has little idea of how much he can sell these products for on the market. A conservative assumption is a 50% markup but still a conservative figure. Sales figures are also going to be based on the annual production capacity. The market is assumed to be much greater than capacity, as the capacity is underdeveloped at Guillermo currently. Sales figures for the furniture are based on past sales performance data.
The breakeven point to be 48.91% of estimated monthly production for March. The company will make enough money to cover overhead on a pre-tax basis (as until the company surpasses overhead it will not be subject to tax). The coating and retardant are estimated to be produced at such low volumes as to be essentially irrelevant to the calculation. The company will be profitable at approximately half of its current expected production level.
Breakeven Analysis
Retardent
Coating
Mid-Grade
High-End
Direct Price
15
46118 / 327,360 = 14.08%
The residual income is in the current situation is net income before taxes less the income tax expense:
46118 -- 19370 = $26, 748.
The economic value added is EVA = NOPAT -- c *K = 26,748 -- (.075) (327,360) = 26,748 -- 24,552 = $2,196. This is based on 7.5% as the WACC. Although the WACC is not given, the cost of debt is 7.5% based on the cost of long-term debt, which accounts for 69% of the total liabilities and equity. The true WACC will be higher, since the cost of equity is going to be higher than the cost of debt. However, with no information from which to derive a cost of equity, the 7.5% estimate is a reasonable approximation. If I higher WACC is to be used to gauge an estimate, say 8%, then the EVA would…
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