In this case, the decision to be made is incorporating new technology as a new project for Aurora Textile Company to ensure continued viability and competitiveness in local and global markets. In a financial crisis, the company needs to decide whether to acquire the Zinser 351 machine as part of its production process or continue using ring-spinning and rotor technology in yarn production.
Key themes surrounding the main issue of sustenance of Aurora entail developing strategies that mitigate the hostile United States economic policy, lowering production costs, customer returns while increasing product cost, quality and volume for regional and international markets. Competition from foreign manufacturing companies in fair economic environments has resulted in most apparel market shifting from Aurora (Eades & Doe, 4). Therefore, Aurora has to do thorough financial and technological analyses to develop solutions that will drive the company out of ruin and return it to its original successful pioneer status.
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The general approach to Aurora’s existing problems and their causes understands how modern markets and industries work. Tentatively, financial analysis of the cash flows and production processes would reveal how the company is failing, which would inform the management on how to incorporate modern solutions to avoid collapse and ensure continued viability. This entails understanding the company as it is with existing machinery, staff and conditions and comparing it to projection based on the incorporation of Zinser 351 in production. Therefore, the new technology, training, and lifespan cost are compared to the output and revenue expected over a specified timeline. The results are subsequently compared to production output and revenue using existing ring-spin machinery. These options are also gauged on how they match up with competing industries, which will advise shareholders to proceed. With the adoption of the Zinser 351, higher-quality yarn will be produced at higher-margin products. This stems from the efficiency involved in this new technology which reduced power, operation and maintenance costs by $0.003/lb. Compared to ring and rotor technology, Zinser 351 required a hefty initial investment of $8.25 million with a one-time staff training program of $50,000.
Furthermore, this new technology would increase customer return cost from $0.077/lb to $0.084/lb, showcased in exhibit 5. Hence, Aurora will shoulder higher customer liabilities, with a 5% lower revenue (Halcyon 278, 6). However, Zinser 351 will result in a conversion cost of $0.40/lb that will highlight the 10% higher sale prices of high-quality yarn and shorter cotton inventories to mitigate the cotton spot prices, as seen in exhibit 6.
Computation of incremental cash flow will involve understanding current cash flow using existing ring-spinning and rotor technology in the remaining plants where calculation will reveal NPV. Incremental cash flow is also calculated on a theoretical basis when financial experts analyze cash flow when Zinser 351 is incorporated with NPV determined. The table below showcase incremental cash flows for Aurora in all scenarios. The formulas used are:
Free Cash Flow = Net Income + Depreciation – Change in Working Capital – Capital Expenditure.
Operating Cash Flow = Operating Income = Depreciation – Taxes + Change in Working Capital.
Building completely different sets of cash flow allow for the easier derivation of NPVs for each set suitable for financial analysis and comparison. It is easier, accurate and quick to build cash flow for a specific scenario than a collection of events or variables. Analysts, through building separate cash flows, can spot errors quickly hence easy rectification. A comprehensive set of cash flow requires a lot of precision and concentration for the conclusion to be valid. For Aurora Textile company, the above table highlighting cash flows for the current machine and the new machine makes it easier for stakeholders to understand the figures and draw viable solutions (Dimond, 6). The decision to shift to Zinser 351 is based on a thorough financial analysis done on Aurora between 1999 and 2002, where calculations done assumed net sales of 500,000lbs weekly production level. Considering a 52-week year and $1.0235/lb selling price, Aurora would record annual sale growth of 2% and 1% in volume and cost, respectively.
Furthermore, SG&A costs would equate to 7% of net sales. The current ring machine value is booked at $800,000 with a depreciation of $200,000 estimated until. Tentatively, the NPV of Aurora, in the Hunter plant running Ring-Spinning, in ten years is $8.9 million.
When it comes to incorporating new technology, the Zinser 351 investment entails selling the existing machine at $608,000 and investing $8.25 million of the new machine and $50,000 on training staff. The first year will see a 5% reduction in sales volume but a 10% increase in selling price. The NPV of the Hunter plant with Zinser 351 will be $14.42 million, as seen in exhibit 3. Incremental cash flows, as shown below, depict an NPV of $6.33 million with an IRR of 28%, which is much higher compared to the 10% rate of running the existing machine (Dimond, 7). Despite working with constants and assumptions to derive these NPVs, the conclusion's facts remain true, showing the need for new technology. The major obstacle would be Aurora's survival in operation for the next decade to realize these figures. But even in calculating NPVs for the next 4 to 5 years, and the selling of the Zinser 351 machine, analysis shows if it can be sold at 50% book value, undertaking the new project requires two years of service to add value to this pioneer textile company.
Aurora's state can be described as a tough sell when a company struggles with negative earing in term of net income. The company and the United States textile industry are collapsing due to retail manufacturers getting raw material cheaply from Asian, Canadian and Caribbean markets who have better economic conditions and trade policies that result in lower manufacturing costs (Halcyon 278, 5). Being a pioneer textile company in the United States, Aurora has to rebrand and revitalize its brand by rejuvenating production processes by investing more money in new technology that would otherwise pay dividends to shareholders.
Factors affecting Aurora and the textile industry, especially in the United States, include the World Trade Organization announcement that banning members from using quotas further opens up the United States market for foreign industries with cheaper production processes and tentatively products yarn (Dimond, 6). Asian textile manufacturers, through globalization, provide cheaper raw materials to apparel companies who deviate from Aurora to reduce costs. Moreover, the government's free-trade policies allow North American and Caribbean countries, which have fairly better and subsidized economic conditions, to burden native United States textile industries with fierce competition through encouraged trading.
Investing in Aurora is a risky but worthwhile endeavour that will allow a pioneer textile company to modernize and compete with global markets in providing high-quality yarn that makes most of the apparel we see. Facing collapse, financial assistance from stakeholders would greatly benefit the company as management is on the verge of investing in new production machinery that would increase production volume at a cheaper cost with increased product pricing and quality.
Aurora’s current financial status depicts a decline in sales from $30 per share to $12 per share, as seen in exhibit 7 (Dimond, 6). The decision on the choice of Zinser 351 over the current ring machine after a thorough analysis of projections on the use of both technologies boils down to the Chief Financial Officer's (CFO) and stakeholders' best interests when it comes to Aurora's survival in a very competitive global market. As the company is continually losing money, Zinser 351 should guarantee redemption for its rapidly falling holdings (Dimond, 7). Despite the CFO being optimistic and adamant the new technology would improve returns of Aurora over the next ten years, there is no confidence that the company will be able to sustain operation for another decade, whence shareholders propose the institution offer dividends to the investors instead of taking risks in a hurdle of massive investment in a technology that offers no immediate guarantee.
Exhibit 1
|
Consolidated Statement of Operations for the Fiscal Years |
||||
|
Ending December 31 1999-2002 |
||||
|
($ thousands) |
||||
|
1999 |
2000 |
2001 |
2002 |
|
|
Pounds shipped (000's) |
187,673 |
190,473 |
151,893 |
144,116 |
|
Average selling price/lb |
1.3103 |
1.2064 |
1.2045 |
1.0235 |
|
Conversion Cost / lb |
0.4447 |
0.4421 |
0.4465 |
0.4296 |
|
Average Raw Material Cost / lb |
0.7077 |
0.6429 |
0.6487 |
0.4509 |
|
Net Sales |
$245,908 |
$229,787 |
$182,955 |
$147,503 |
|
Raw Material Cost |
132,812 |
122,461 |
98,536 |
64,982 |
|
Cost of Conversion |
83,454 |
84,212 |
67,822 |
61,912 |
|
Gross Margin |
29,641 |
23,114 |
16,597 |
20,609 |
|
SG&A Expenses |
14,603 |
14,218 |
11,635 |
10,305 |
|
Depreciation & Amortization |
15,241 |
13,005 |
11,196 |
9,859 |
|
Operating Profit |
(203) |
(4,109) |
(6,234) |
445 |
|
Interest Expense |
6,777 |
6,773 |
5,130 |
3,440 |
|
Other Income (Expense) |
1,143 |
(1,232) |
(409) |
|
|
Asset Impairments* |
4,758 |
7,564 |
||
|
Earnings Before Income Tax Provision |
(6,980) |
(9,739) |
(17,354) |
(10,968) |
|
Income Tax Provision (Benefit) @ 36% tax rate |
(2,513) |
(3,506) |
(6,247) |
(3,949) |
|
Net Earnings |
($4,467) |
($6,233) |
($11,106) |
($7,020) |
|
* Costs associated with the shutdown of plants |
||||
Exhibit 2
|
Consolidated Balance Sheets for the Fiscal Years |
||||
|
Ending December 31 1999-2002 |
||||
|
($ thousands) |
||||
|
1999 |
2000 |
2001 |
2002 |
|
|
Assets |
||||
|
Cash and cash equivalents |
$1,144 |
$5,508 |
$2,192 |
$1,973 |
|
Accounts receivable, net |
17,322 |
11,663 |
20,390 |
26,068 |
|
Inventories |
34,778 |
33,155 |
31,313 |
33,278 |
|
Other current assets |
2,774 |
1,922 |
712 |
2,378 |
|
Total Current Assets |
$56,018 |
$52,247 |
$54,608 |
$63,697 |
|
Property and Equipment |
||||
|
Land |
2,654 |
2,594 |
2,516 |
2,505 |
|
Buildings |
32,729 |
31,859 |
30,308 |
30,427 |
|
Machinery and equipment |
230,759 |
220,615 |
197,889 |
190,410 |
|
Gross PP&E |
266,142 |
255,068 |
230,713 |
223,342 |
|
Less accumulated depreciation |
(147,891) |
(147,104) |
(146,302) |
(154,658) |
|
Net PP&E |
118,250 |
107,964 |
84,411 |
68,684 |
|
Goodwill |
1,180 |
1,180 |
1,180 |
1,180 |
|
Other non-current assets |
3,516 |
3,499 |
2,824 |
2,430 |
|
Total Assets |
$178,965 |
$164,890 |
$143,023 |
$135,991 |
|
Liabilities |
||||
|
Accounts payable |
12,236 |
7,693 |
9,667 |
10,835 |
|
Accrued compensation and benefits |
4,148 |
3,712 |
4,176 |
4,730 |
|
Accrued interest |
1,830 |
1,090 |
961 |
929 |
|
Other accrued expenses |
4,083 |
3,914 |
3,881 |
3,657 |
|
Current portion of long-term debt |
1,009 |
1,730 |
0 |
0 |
|
Total Current Liabilities |
$23,306 |
$18,139 |
$18,685 |
$20,151 |
|
Long-term debt |
66,991 |
66,991 |
58,000 |
58,000 |
|
Other long-term liabilities |
16,566 |
14,081 |
11,776 |
10,297 |
|
Total Liabilities |
$106,863 |
$99,211 |
$88,461 |
$88,448 |
|
Shareholder's equity |
||||
|
Common stock, par $0.01 |
50 |
50 |
50 |
50 |
|
Capital surplus |
15,868 |
15,678 |
15,668 |
15,668 |
|
Retained earnings |
56,184 |
49,951 |
38,845 |
31,825 |
|
Total Shareholders' Equity |
$72,102 |
$65,679 |
$54,563 |
$47,543 |
|
Total Liabilities and Shareholders' Equity |
$178,965 |
$164,890 |
$143,023 |
$135,991 |
|
Plant Production Capability |
||||
|
Plant |
Technology |
Product Mix |
Count Range |
Capacity |
|
Hunter |
Ring |
100% Cotton |
5/1 to 22/1 |
600,000 |
|
Rome |
Rotor |
100% Cotton |
5/1 to 22/1 |
1,200,000 |
|
Barton |
Rotor |
Heather and Poly/Cotton Blends |
8/1 to 30/1 |
800,000 |
|
Butler |
Rotor |
100% Cotton |
5/1 to 30/1 |
1,000,000 |
|
Cost of Customer Returns |
||||||
|
Existing machine |
Calculation |
|||||
|
Price of Yarn Sold |
$5.0 |
|||||
|
Reimbursement cost |
$25.0 |
|||||
|
Liability multiplier |
5.0 |
(25/5) |
||||
|
Returns as % of Volume |
1.50% |
|||||
|
Returns as % of Revenue |
7.50% |
(5 x 1.5%) |
||||
|
Returns as cost/lb |
$0.077 |
(7.5% x $1.0235/lb) |
||||
|
Zinser |
Calculation |
|||||
|
Price of Yarn Sold |
$10.0 |
|||||
|
Reimbursement cost |
$75.0 |
|||||
|
Liability multiplier |
7.5 |
(75/10) |
||||
|
Returns as % of Volume |
1.00% |
|||||
|
Returns as % of Revenue |
7.50% |
(7.5 x 1.0%) |
||||
|
Returns as cost/lb |
$0.084 |
(7.5% x $1.0235/lb x 110%) |
Exhibit 6
|
Interest Rate Yields: January 2003 |
|||||
|
U.S. Government (% yield) |
|||||
|
Treasury bill (1-year) |
1.24% |
||||
|
Treasury note (10-year) |
3.98% |
||||
|
Treasury bond (30-year) |
4.83% |
||||
|
Industrials (% yield) |
|||||
|
Prime rate 1 |
4.25% |
||||
|
AAA (10-year) |
4.60% |
||||
|
A.A. (10-year) |
4.66% |
||||
|
A (10-year) |
4.87% |
||||
|
B.B. (10-year) |
5.60% |
||||
|
BBB (10-year) |
6.90% |
||||
|
1 The prime rate was the short-term interest rate charged by large U.S. banks |
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|
For corporate clients with strong credit ratings. |
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Works Cited
Dimond, Michael. “Aurora Textile Company.” Portland State University , 2021. Darden Business Publishing, University of Virginia.
Eades, Kenneth & Doe, Lucas. “Aurora Textile Company Harvard Case Solution & Analysis.” The Case Solutions , 2007: https://www.thecasesolutions.com/aurora-textile-company-7228 Accessed 17 th March 2021.
Halcyon 278. “Aurora Textile Case.” Essays 24 , 2015: https://www.essays24.com/essay/Aurora-Textile-Case/64201.html Accessed 17 th March 2021.
