Case 20 : Aurora Textile Company

Case 20 morning cloth troupe GROUP QUESTIONS acquirement Objectives 1. The basics of additive- bullion-flow outline identifying the silver flows pertinent to a capital- enthronement determination 2. The construction of a side-by-side discounted- bills-flow analysis for a tackment decision 3. How to adapt the NPV decision rule to a troubled exertion 4. The recognition that a reduced garmentment horizon is a signifi dismisst consequence of pecuniary tribulation 5. The importance of sensitivity analysis to a capital-investment decision Case Questions 1. How has sunrise cloth performed over the past quartette long sequence?Be prep atomic number 18d to provide financial ratios that present a clear portraying of Auroras financial condition. From 1999 by dint of 2002, the financial performance of Aurora was unpresentable and disheartening. This could be attributed to the business risks that arose from the intense contest that characterizes the industry in which Aurora operates. vanish an industry benchmark or comparable to(predicate) with which to gauge the performance of Aurora, we utilized a trend analysis of the period 1999 d adept 2002. With 1999 as a reference point, we start out that all mea reals of utilityability have worsened.On a cumulative annual basis, net gross gross revenue have been declining by 15%, date profit margins and ROA were always in the oppose (see let on 1). sequence raw corporal personify as a section of net sales have been declining, the live of conversion is escalating and poignant the bottom-line (see exhibit 1). It is patent that Aurora demand to manage its expenses to begin profits from sales. While on the surface, the fluidness measures have improved (see exhibit 1), it is enigmatic that the gild has the ability to meet its flow obligations with just silver and cash equivalents on hand.This is partially callable to the concomitant that numerous of the firms current assets are predominan tly account receivables and inventories. While it is unbent that the firm, its competitors, and the industry are continuing to regress money, an effective personify-control outline i. e. a strategy that improves profit margins, reduces operating costs, and fittingly manages stock list and account receivables go away be of the essence(p) for Aurora to remain sustainable. 2. List the factors affecting the fabric industry. What do you think is the put up of the industry in the United States?How should you control the state of the textile industry into your analysis? Why should anyone invest money in the industry? 3. What are the relevant cash flows for the Zinser investment? Using a 10% WACC and assuming a 36% tax income rate, what do you get as the NPV for the regard? What are the look on drivers in your analysis? What do you estimate as the cost per pound for customer returns under the Zinser choice? (Hint for a replacement decision, analysts often find it helpful to pr epare two sets of cash flows and two NPVsone for the spot quo and one for the invigorated railway car. Status Quo In the outset line of products of study of the discombobulate, we compute net sales assuming the current 500,000 pounds per week occupation level at a $1. 0235 change price per pound (52-week course of study). After the premiere 3 year, we assume sales give grow by 2% in volume and 1% in price. material and conversion costs lead non change, but exit increase at a pace of 1%. SG&A costs are equal to 7% of net sales so testament adjust accordingly. Change in lineage is cash spent so it should be considered when calculating cash flows.In our analysis we calculated inventory by dividing COGS by the deem of days in a year and then multiplying by the number of days of inventory held, 30 days in the condition quo scenario. The current equipment give be depreciated using the straight-line method with zero remedy value. The current bind value of the rail car is $800,000 and the depreciation expense is $200,000 for the next four-spot years. Using these assumptions, keeping all else regular, in a 10-year horizon the NPV of the hunter lay down is to the highest degree $8. 1 million (see exhibit 2). New Project Invest in Zinser Machine Aurora Textile fellowship also has the option of place in a new Zinser machine for the huntsman Plant. The main difference between investing in the Zinser machine and maintaining the status quo is an sign investment of $8. 25 million and the know of $608,000 in after-tax sales proceeds from sell the existing machine. Additionally, there is an initial $50,000 ($32,000 after-tax) cost for training employees, but this cost is sole(prenominal) incurred once (see exhibit 3).In their first year using the Zinser machine there exit be a 5% slack in sales volume, but selling price will increase 10%. Material costs per pound will be the same as the status quo, but conversion costs will decrease to $ 0. 4077 per pound per year due to lower power, maintenance and return costs. eld of inventory held will also contrive to around 20 days. All opposite assumptions are the same as the status quo. In this scenario, the NPV of the Hunter Plant is almost $15. 87million if Aurora invests in the new Zisner machine (see exhibit 3). Incremental Cash Flows The utmost Effect of the New ProjectWhen looking at the incremental cash flows for the new exteriorise, substitute the old machine with the Zinser machine is a good investment. The NPV of the investment is $6. 33 million and the IRR is 28%, a lot higher(prenominal)(prenominal) than the 10% hurdle rate (see exhibit 4). While all the assumptions made could affect the NPV of the project, the major(ip) concern that could erode the value of the project is whether Aurora can survive for 10 years. In our early termination analysis (see exhibit 5), if we ignore the salvage value the time horizon breakeven point of incremental NPV is betwe en 4 and 5 years, about 4. years. However, even if Aurora shuts down, the earlier they terminate, the higher the salvage value of the Zinser machine will be. Therefore, the time period to breakeven might be less than 4 years. If the Zinser machine can be sold for its 50% book value at early termination, it provided needs 2 years for the project to add value to the Aurora Textile caller-out. 4. How sensitive is the economic life of the Zinser investment to its value to investors? In other words, if the lodge survives the entire 10 years, what is the NPV of the project?What if the company can survive only four years, what is the NPV of the project? For our sensitivity analysis, the main things we centre on were return levels and price. Here is a chart representing the IRRs for certain production levels and prices. Our production level estimates were ground on the fact that we dont know how the marketplace will react with increased unconnected competition. The textile harvest- time rate we utilize for our most likely model is the house servant rate of increase, not the world growth rate.We dont know if permit foreign competitors into the market would significantly faulting the industry out of America or if it will keep a constant growth (at 2%). Our price estimates were based on the new WTO mandate that is dismissal into effect in 2005. With the tariffs and quotas on the textile industry being lifted, there will be a significant growth in the amount of textile goods trade into America. Even though the cost may be high to transport these goods into the states 5. What would be your recommendation to the Board of Directors?Specifically would it be better to invest in the Zinser or to pay a dividend to the shareholders. Be sure to explain the primary reasons that justify your recommended course of action. The U. S. textile industry is going through with(predicate) a tumultuous time, and most companies are experiencing losses. Therefore, it would seem like an odd time to invest more money into the company. However, as the industry evolves Aurora Textile Company needs to innovate to stay competitive. The industry is moving toward demand for a higher quality product, and Aurora cannot afford to come across behind.The Zinser machine will help Aurora meet this demand. If the project were accepted, the Zinser machine would replace the current machine in the Hunter Plant. Because the other three Aurora plants would not be affected by this decision, we compared the cash flows of only the Hunter plant with the new machine and without. The NPV of the Hunter Plant is about $15. 86 million if Aurora invests in the Zisner machine, and only $8. 91 million without the investment. In addition, when looking at the incremental cash flows of the investment, the NPV is $6. 6 million and the IRR is 28%, much higher than the 10% hurdle rate. victorious all of this into consideration Aurora should invest in the project. In addition to pass judgment this project, falling spot prices for cotton could be beneficial to Aurora Textile Company in the future. However, the company also needs to implement other strategies to improve their profit margins, including reducing operating costs and appropriately managing inventory and account receivables. These changes will help Aurora move in the mighty direction to ensure that they are not forced to shut down operations in the foreseeable future