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Aurora Textile Company

Case solution
Company Background
Aurora Textile Company is in a tough situation due to the troubled financial condition of both
the company and the U.S. textile industry as a whole. Manufacturers are migrating to Asia to
benefit from lower manufacturing costs and Aurora does not want to move operations
overseas. With net earnings in the negative, Aurora must now make the tough decision on
whether to invest more money into a struggling company or maintain the status quo.
Financial Analysis (1999 2002)
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 comparables with which to gauge the performance of Aurora, we utilized a
trend analysis of the period 1999 through 2002.
Status Quo
We calculated net sales assuming the current 500,000 pounds per week productionlevelata
$1.0235 selling price per pound (52-week year). After the first 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.The current equipment will be depreciatedusing 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 $8.9 million.
New Project - Invest in Zinser Machine
The main difference between investing in the Zinser machine and maintaining the status quo
is an initial investmentof $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
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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
costswill 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 $14.42 million if
Aurora invests in the new Zisner machine (see exhibit 3).
Incremental Cash Flows -The Net Effect of the New Project
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 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
valuethe time horizon breakeven point of incremental NPV is between 4 and 5 years, about
4.5 years. 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 only needs 2 years for the
project to add value to the Aurora Textile Company.
Recommendation
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 fall behind. The
Zinser machine will help Aurora meet this demand.The NPV of the Hunter Plant is about
$14.42 million if Aurora invests in the Zisner machine, andonly $8.9 million without the
investment. In addition, when looking at the incremental cash flows of the investment, the
NPV is $6.33 million and the IRR is 28%, much higher than the 10% hurdle rate. Taking all
of this into consideration Aurora should invest in the project.

Aurora Textile Company


Financial Ratios Analysis (19992002)

1999
Sales growth
Raw materials/sales
Conversion cost/sales
Gross Margin/sales
SGA/sales

54.01%
33.94%
12.05%
5.94%

2000
6.56%
53.29%
36.65%
10.06%
6.19%

2001
20.38%
53.86%
37.07%
9.07%
6.36%

2002
19.38%
44.05%
41.97%
13.97%
6.99%
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Interest Expense
Operating Profit/sales
NI/sales
Days sales outstanding
Days inventory
Asset turnover
Return on assets
Return on equity

2.76%
-0.08%
-1.82%

2.95%
-1.79%
-2.71%

2.80%
-3.41%
-6.07%

2.33%
0.30%
-4.76%

25.7
95.6
1.37

18.5
98.8
1.39

40.7
116
1.28

64.5
186.9
1.08

2.5%
6.2%

3.8%
9.5%

7.8%
20.4%

5.2%
14.8%

Note: Although the sale growth increased through the four years except 2001.consequintly,
the gross profit increased from 12.05% to 13.97% at the end of the year 2002. On the other
hand, the net profit was negatives value. Throughout the four years, From this analysis it
can be concluding that the company's financial performance was tremendously bad.

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Aurora Textile Company


Investment Outlay and Terminal-Value Calculations

Sale of Existing Ring-Spinning Machine


Book value
Current Market value
Loss
Tax savings (36%)
Net proceeds for existing machine

$2,000,0
00
500,000
1,500,00
0
540,000
$1,040,0
00

Purchase of the Zinser


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$8,050,0
00
115,000
55,000
30,000
$8,250,0
00

Price of Zinser
Building modification
Airflow modification
Testing
Total cost

Sale of the Zinser at the End of Year 10


Book value
Market value
Gain
Tax on gain @36%
Net proceeds

$0
100,0
00
100,0
00
36,00
0

$64,0
00

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