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Summary and Problem:Aurora Textile Company (ATC), a yarn manufacture company which was established

in the early 1900s, catered to both domestic and international textile industries.
Aurora Textile financial performance has been poor during the last few years. Its
four main major customer segments are hosiery, knitted outerwear, woven and
industrial and specialty products. Also, Auroras managers believe that the woven
market provides the best growth opportunity.. Aurora was left with four operational
manufacturing plants after Aurora had to close four of its inefficient manufacturing
plants in 2000. The operational manufacturing plants include Hunter, Rome, Barton
and Butler.
Aurora relied heavily on the domestic textile market which compromised of 90% of
its total revenue. But even in the domestic market aurora faced strict challenge and
severe competition in the textile-mill industry which drove its margins to minimum.
Relaxed trade policy of the United States and cheaper productions costs overseas
meant that many yarn-manufacturing firms now moved abroad and started
exporting their products to the US aggressively. A factor that contributed to the
increased difficulty of aurora was shift in consumer preferences and fads which were
experiencing a shift towards finer-quality yarn with minimum defects. Also the trend
of customized goods increased. Additionally, enhancements in computerized
technology eased the trace-back of defective products which resulted in increased
dollar liability per garment. Moreover, a forthcoming ban on trade-quotas and Trade
agreements resulted in an even more competitive domestic environment. As a
result, Auroras demand for its products was affected heavily due to an
overwhelming influx of similar products from overseas.
Regarding the processes, Ring spinning process was currently part of the operations
at only one of Auroras four plants: Hunter. Even though the current process
produced a higher quality of yarn, however, it was relatively expensive. A new
spinning machine was suggested in place of it, and that is where Zinser 351 and
Michael Pogonowski come into the spotlight.
Michael Pogonowski, CFO at Aurora Textile Company, had to make a challenging
decision of wether replacing the older-generation spinning machine with Zinser 351,
a new ring-spinning machine, at Auroras Hunter production facility which could
prove crucial to ATCs future.
The adverse financial climate was such that Aurora had faced consecutive losses for
four years and as a result the company now faced a difficult situation concerning its
working capital and cash flows. Michael now had to weigh in the costs and benefits
of the Zinser 351. The company used a hurdle rate of 10% for such replacement
projects. Zinser would produce a higher-quality yarn, thus enabling Aurora to charge
a price that would be 10% higher than before. Moreover, lower power consumption
and maintenance expenses would result in a savings of $0.03/lb. But since due to
the increase in the price, the sales volume would suffer by suffer by 5%. Also note
that the dollar liability per garment would now be higher since the superior product
would cater to a higher-end market. To add to these down factors is the intimidating
cost of USD 8.25 million which further increases the risk of the project. Also despite
the increased reliability of Zinser, the plant manager of Hunter viewed this as a

threat to his strategy of changing inventory in accordance with the varying price
trends. Also, cheap labor opportunities abroad further challenge the existence of
Aurora. Additionally, price of Zinser 351 is increasing at a rate of 5% annually
further increasing the tension. As a result, a delay in the project can seriously harm
Aurora textile financially. Thus these mixed views added to the difficulty of the
CFOs decision who was confident that the project would provide a greater return
than the hurdle rate, but was rather unsure if Aurora would even live to see this
benefit.
Analysis of the problem:
(NOTE: Most of the numbers given are in thousands)
We have calculated the NPV and IRR for the two projects 1) Using existing
Machinery, 2)Using Zinser 351. Also we have calculated incremental IRR. We will go
through some basic assumptions, and for your reference I have attached some of
our exhibits.
First of all we will go through the case where Aurora uses Zinser and replaces
existing machinery, But before that we will need the initial Cashflow when replacing
the machine. Following is the Cash Flow:

Initial CF ($ 000)
Zinster Cost
Add training cost
Sale Value of Old machine
Book Value
Loss on Sale
Tax Gain on Loss of
Sale
Initial Outflow

8250
50
500
2000
1500
540
($7,260.0
0)

As we can see the initial outflow is -7260 (in thousands)


Also the depreciation for Zincer is as follows:

Depreciation of Zinser ($)


Machinery Cost
Scrap Value
Useful Life
Depreciation per
year
Depreciation per
year ($ 000)
The new conversion cost is:

$8,250,000
$0
10
$825,000
825

New Conversion Cost


($/lb)
Current conversion cost
Increase in Customer returns
Decrease in power &
maintenance

0.43
0.00
7

0.03
0.4
Conversion Cost
07
Next we can calculate the forecasted income statement (look in the excel sheets).
Some assumptions taken include 1% Inflation rate, 8.25 million machine will be
depreciated over 10 years, no considerable changes in inventory, 0.2 % annual
growth rate for the next 10 years and annual production =weekly prod * 52. Also SG
and A expenses were estimated at 7% of Net sales. Once we got the NOPAT we
calculated free cash flows as well (look in the exhibit for more details. We got the
following results:

Hurdle Rate
NPV of Zinser 351
IRR

10%
$10,626.73
40.34%

Now to show that using Zinser was better than existing machine we used the
concept of Incremental IRR and NPV, For that we took similar assumptions (as
stated above) and calculated the forecasted income statement for existing machine
and found the free cash flows with existing machine. Then we calculated
Incremental Cash flows, then Incremental IRR and NPV and the results were as
follows:
Hurdle Rate
Incremental NPV
Incremental IRR
Profitability Index
Payback Period
Discounted Payback Period

10%
$3,086.92
19.55%
2.44
4.08 years
5.12 years

As we can see the Incremental IRR is greater than hurdle rate and Incremental NPV
is greater than zero, therefore Zinser project should be accepted.
Recommendations:Apart from the numbers we would recommend that based on the current market
conditions, it would be wise of Michael Pogonowski to not only rely on numbers.
With a reasonable hurdle rate of 10%, the decision to incorporate Zinser 351 in the
operations at Hunter facility seems to be the appropriate one since the benefits
outweigh the costs involved, however management needs to consider other options

which includes to either close down one or two of Auroras rotor-technology plants
(say Rome and Butler) in order to set up a manufacturing plant abroad where
production costs are significantly less. Thus the dependency of Aurora on the
domestic industry will decrease. Also, Aurora to rank its product segments and
terms of growth and focus on them accordingly. For example Aurora could
strengthen its stronghold in wovens segment which believed to have a lot of growth
potential. Similarly, Industry and specialty products also present favorable prospects
for growth because of their high-margins. If the Zinser operation as well as these
strategies can be implemented, they can turn around the table for Aurora.

Exhibits
For Zinser Machine (Projected Income statement and
FCFs)

For Existing machine (Projected Income statement and


FCFs)