Aurora Textile Company Case Essay

932 Words Jul 15th, 2014 4 Pages
Aurora Textile Company Case
Abstract
In January 2003, Michael Pogonowski, the chief financial officer of Aurora Textile Company, was questioning whether the company should install a new ring-spinning machine, the Zinser 351, in the Hunter production facility. This new machine has ability to produce a finer-quality yarn that would be used for higher-quality and higher-margin products. In deciding whether or not to invest this new machine, NPV and the payback period are critical factors. Firstly, we need to forecast the cash flows that the Zinser 351 will generate in the future. After calculation, the ten-year NPV will be $3, 172,582. Secondly, we use the payback period to analyze the acceptance of this project. Based on this analysis,
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($0.0844/lb. − $0.0768/lb.). Thus, the conversion cost for Zinser equals $0.4077/lb. ($0.43 – 0.03 + 0.0077).
Inventory: Inventory equals COGS divided by number of days in a calendar year (360) times number of days of inventory (20). The cash flow equals the change in inventory level each year until year 10, when the inventory level is recovered.
Depreciation: Depreciation was computed using the straight-line method. The value of the Zinser was $8.25 million and the depreciable life was 10 years, making for an annual depreciation expense of $825,000.
Net initial investment: $8.25 million. The total cash payment is offset by the after-tax proceeds from the sale of the existing spinning machine.

We used Free Cash Flow to calculate the ten-year NPV. Our calculations yielded a NPV of $3,172,582 as we use the hurdle rate of 10%. In conclusion, the NPV for the long-term forecasts is positive so we should accept to install the Zinser 351. Moreover, after predicting the next ten-year discounted free cash flows, we were able to calculate the discounted payback period of 5.69, comparing with the arbitrary cut off point 7.87. For the arbitrary cut off point, we use the average return on equity (net income/total equity) of the past 4 years, which is -12.702%, because it is more accurate and consistent than using the ROE of 2002. Then, we assume that all the equity leaves the company at
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