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Aurora Textile Company Essay

1957 words - 8 pages

Case Questions

1. How has Aurora Textile performed over the past four years? Be prepared to provide financial ratios that present a clear picture of Aurora’s financial condition.

From 1999 through 2002, the financial performance of Aurora was unattractive and disheartening. This could be attributed to the business risks that arose from the intense competition that characterizes the industry in which Aurora operates. Absent an industry benchmark or comparable with which to gauge the performance of Aurora, we utilized a trend analysis of the period 1999 through 2002.
With 1999 as a reference point, we noticed that all measures of profitability have worsened. On a cumulative annual ...view middle of the document...

What are the relevant cash flows for the Zinser investment? Using a 10% WACC and assuming
a 36% tax rate, what do you get as the NPV for the project? What are the value drivers in your analysis? What do you estimate as the cost per pound for customer returns under the Zinser alternative? (Hint: for a replacement decision, analysts often find it helpful to prepare two sets of cash flows and two NPVs—one for the status quo and one for the new machine.)
Status Quo 
In the first year of the project, we calculated net sales assuming the current 500,000 pounds per week production level at a $1.0235 selling price per pound (52-week year). After the first 3 year, we assume sales will grow by 2% in volume and 1% in price. Material and conversion costs will not change, but will increase at a pace of 1%. SG&A costs are equal to 7% of net sales so will adjust accordingly. Change in inventory is cash spent so it should be considered when calculating cash flows. In our analysis we calculated inventory by dividing COGS by the number of days in a year and then multiplying by the number of days of inventory held, 30 days in the status quo scenario. The current equipment will be depreciated using the straight-line method with zero salvage value. The current book value of the machine is $800,000 and the depreciation expense is $200,000 for the next four years. Using these assumptions,
keeping all else constant, in a 10-year horizon the NPV of the Hunter Plant is about $8.91 million (see exhibit 2).

New Project - Invest in Zinser Machine 
Aurora Textile Company also has the option of investing in a new Zinser machine for the Hunter Plant. The main difference between investing in the Zinser machine and maintaining the status quo is an initial investment of $8.25 million and the receipt of $608,000 in after-tax sales proceeds from selling the existing machine. Additionally, there is an initial $50,000 ($32,000 after-tax) cost for training employees, but this cost is only incurred once (see exhibit 3). In their first year using the Zinser machine there will be a 5% decrease 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. Days of inventory held will also drop to about 20 days. All other assumptions are the same as the status quo. In this scenario, the NPV of the Hunter Plant is about $15.87million if Aurora invests in the new Zisner machine (see exhibit 3).

Incremental Cash Flows - The Net Effect of the New Project 
When looking at the incremental cash flows for the new project,
replacing 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%, much higher than the 10% hurdle rate (see exhibit 4). While all the assumptions made could affect the NPV of the project, the major concern that could erode the...

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