Guillermo Furniture Essay

791 Words Sep 17th, 2011 4 Pages
This memo serves to provide information concerning capital budget recommendations for Guillermo Furniture. The firm has come to a crossroads in its industry. Due to competitive forces that have recently entered the firm’s market, the firm must decide if it should make capital investments to become a high tech manufacturer, become a distributor, or due nothing and continue its traditional course of operations.
Capital investments are instrumental to future successes realizable by Guillermo and “business profitability ultimately hinges, to a large extent, on the quality of a few capital investment decisions” (Edmonds, 2007). As a result, we will explore recommendations for Guillermo to vacate its current landscape of operations for a
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As a result of this, managers are inclined to use IRR. This technique allows managers the ability to calculate the rate of return where present value of cash inflows and outflows of the investment are equal. Once the firm calculates the IRR it can directly compare that rate with the desired rate and decide if the investment will be acceptable or not.
Conversely, NPV is represented in absolute dollars, and IRR only uses one discount rate. This gives rise to additional differences between NPV and IRR. Costly capital investments can possess higher NPV than smaller investments, but smaller investments can have a higher rate of return.
Explanation
IRR explicitly conveys the calculated rate of return and when this calculation is compared to the cutoff rate, and used systematically and without prejudice for all capital investments, management decisions are facilitated. Managers are able to prioritize capital investments according to potential profitability. Although, the use of IRR makes comparisons easier, it does not take into account any future changes in the discount rate, thus making this technique substandard for long term capital investments that may experience varying discount rates such as the capital investment initiatives of Guillermo.
The use of IRR will also be less effectual in Guillermo’s niche furniture market. Consumer tastes change and the dynamics of this market would encourage changes in the calculated rate of return,

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