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  • Word Note Aurora Textile Case Zinser 351

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    alka murarka
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    Aurora Textile Company was a yarn manufacturer established in early 1990s to service both domestic and international textile industry. The company manufactures cotton and synthetic / cotton blend yarns that were sold to variety of apparel and industrial-goods manufacturers that sold their products in the U.S retail markets. Aurora serviced four customer segments: hosiery, knitted outwear, wovens and industrial and special products. The U.S textile-mill industry had experienced major challenges over the years due to globalization, the U.S. Government trade policies, low cost advantage to overseas players and consumer preferences and fads. Search for lower production cost has shifted most of the players to Asian markets. The U.S yarn manufacturers were declining in numbers and facing tougher and tougher competition from heavy influx of imported yarns. Besides the strong U.S Dollars also made it more appealing for many foreign textile manufacturers to export and flood the U.S market putting more and more pressure on in-house manufacturers. Companies like Aurora, which had kept their manufacturing base exclusively in the U.S. were forced to cut costs and modernize their operations to remain competitive. Aurora Textile’s financial had been marred over last few years because of changing industry dynamics. The company had been reporting decline in sales year-after-year leading to losses both at operating as well as net level. The steady decline in sales and business losses had led to management’s decision to close four operating facilities in 2000 in an effort to right size Aurora’s capacity to shrinking textile market and reduce manufacturing costs. The company, in 2003, had four operating plants: Hunter, Rome, Barton and Butler. Aurora is considering a proposal to evaluate the economic benefit of installing a new generation ring-spinning machine “Zinser 351” in the Hunter production facility by replacing an old machine so as to increase Aurora’s ability to produce finer-quality yarn to be used for manufacturing higher-quality and higher-margin products besides increasing efficiency by reducing costs and brings greater reliability product quality by reducing customer returns. The major question that the CFO, Michael Pogonowski was asking is whether to go ahead and install “Zinser 351”. The report presents the financial feasibility of “Zinser 351” and if it makes sense for the management and shareholders to skip dividends and invest into new machinery and equipment.

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    Aurora Textile Company was a yarn manufacturer established in early 1990s to service both domestic and international textile industry. The company manufactures cotton and synthetic / cotton blend yarns that were sold to variety of apparel and industrial-goods manufacturers that sold their products in the U.S retail markets. Aurora serviced four customer segments: hosiery, knitted outwear, wovens and industrial and special products. The U.S textile-mill industry had experienced major challenges over the years due to globalization, the U.S. Government trade policies, low cost advantage to overseas players and consumer preferences and fads. Search for lower production cost has shifted most of the players to Asian markets. The U.S yarn manufacturers were declining in numbers and facing tougher and tougher competition from heavy influx of imported yarns. Besides the strong U.S Dollars also made it more appealing for many foreign textile manufacturers to export and flood the U.S market putting more and more pressure on in-house manufacturers. Companies like Aurora, which had kept their manufacturing base exclusively in the U.S. were forced to cut costs and modernize their operations to remain competitive. Aurora Textile’s financial had been marred over last few years because of changing industry dynamics. The company had been reporting decline in sales year-after-year leading to losses both at operating as well as net level. The steady decline in sales and business losses had led to management’s decision to close four operating facilities in 2000 in an effort to right size Aurora’s capacity to shrinking textile market and reduce manufacturing costs. The company, in 2003, had four operating plants: Hunter, Rome, Barton and Butler. Aurora is considering a proposal to evaluate the economic benefit of installing a new generation ring-spinning machine “Zinser 351” in the Hunter production facility by replacing an old machine so as to increase Aurora’s ability to produce finer-quality yarn to be used for manufacturing higher-quality and higher-margin products besides increasing efficiency by reducing costs and brings greater reliability product quality by reducing customer returns. The major question that the CFO, Michael Pogonowski was asking is whether to go ahead and install “Zinser 351”. The report presents the financial feasibility of “Zinser 351” and if it makes sense for the management and shareholders to skip dividends and invest into new machinery and equipment.

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    Word Note Aurora Textile Case Zinser 351

    Caricato da

    alka murarka
    Aurora Textile Company was a yarn manufacturer established in early 1990s to service both domestic and international textile industry. The company manufactures cotton and synthetic / cotton blend yarns that were sold to variety of apparel and industrial-goods manufacturers that sold their products in the U.S retail markets. Aurora serviced four customer segments: hosiery, knitted outwear, wovens and industrial and special products. The U.S textile-mill industry had experienced major challenges over the years due to globalization, the U.S. Government trade policies, low cost advantage to overseas players and consumer preferences and fads. Search for lower production cost has shifted most of the players to Asian markets. The U.S yarn manufacturers were declining in numbers and facing tougher and tougher competition from heavy influx of imported yarns. Besides the strong U.S Dollars also made it more appealing for many foreign textile manufacturers to export and flood the U.S market putting more and more pressure on in-house manufacturers. Companies like Aurora, which had kept their manufacturing base exclusively in the U.S. were forced to cut costs and modernize their operations to remain competitive. Aurora Textile’s financial had been marred over last few years because of changing industry dynamics. The company had been reporting decline in sales year-after-year leading to losses both at operating as well as net level. The steady decline in sales and business losses had led to management’s decision to close four operating facilities in 2000 in an effort to right size Aurora’s capacity to shrinking textile market and reduce manufacturing costs. The company, in 2003, had four operating plants: Hunter, Rome, Barton and Butler. Aurora is considering a proposal to evaluate the economic benefit of installing a new generation ring-spinning machine “Zinser 351” in the Hunter production facility by replacing an old machine so as to increase Aurora’s ability to produce finer-quality yarn to be used for manufacturing higher-quality and higher-margin products besides increasing efficiency by reducing costs and brings greater reliability product quality by reducing customer returns. The major question that the CFO, Michael Pogonowski was asking is whether to go ahead and install “Zinser 351”. The report presents the financial feasibility of “Zinser 351” and if it makes sense for the management and shareholders to skip dividends and invest into new machinery and equipment.

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    Aurora Textile Company


    Financial Feasibility for machine Zinser 351
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    3/2/2016
    For full set of answer, Please mail me at alkamurarkaa@gmail.com
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    Aurora Textile Company was a yarn manufacturer established in early 1990s to service both domestic and
    international textile industry. The company manufactures cotton and synthetic / cotton blend yarns that were sold to
    variety of apparel and industrial-goods manufacturers that sold their products in the U.S retail markets. Aurora
    serviced four customer segments: hosiery, knitted outwear, wovens and industrial and special products. The U.S
    textile-mill industry had experienced major challenges over the years due to globalization, the U.S. Government
    trade policies, low cost advantage to overseas players and consumer preferences and fads. Search for lower
    production cost has shifted most of the players to Asian markets. The U.S yarn manufacturers were declining in
    numbers and facing tougher and tougher competition from heavy influx of imported yarns. Besides the strong U.S
    Dollars also made it more appealing for many foreign textile manufacturers to export and flood the U.S market
    putting more and more pressure on in-house manufacturers. Companies like Aurora, which had kept their
    manufacturing base exclusively in the U.S. were forced to cut costs and modernize their operations to remain
    competitive. Aurora Textiles financial had been marred over last few years because of changing industry dynamics.
    The company had been reporting decline in sales year-after-year leading to losses both at operating as well as net
    level. The steady decline in sales and business losses had led to managements decision to close four operating
    facilities in 2000 in an effort to right size Auroras capacity to shrinking textile market and reduce manufacturing
    costs. The company, in 2003, had four operating plants: Hunter, Rome, Barton and Butler. Aurora is considering a
    proposal to evaluate the economic benefit of installing a new generation ring-spinning machine Zinser 351 in the
    Hunter production facility by replacing an old machine so as to increase Auroras ability to produce finer-quality
    yarn to be used for manufacturing higher-quality and higher-margin products besides increasing efficiency by
    reducing costs and brings greater reliability product quality by reducing customer returns. The major question that
    the CFO, Michael Pogonowski was asking is whether to go ahead and install Zinser 351. The report presents the
    financial feasibility of Zinser 351 and if it makes sense for the management and shareholders to skip dividends
    and invest into new machineries and equipment.
    About Zinser 351

    Zinser 351 will have the ability to produce finer-quality yarn that would be used for

    higher-quality and higher-margin products. The new facility would provide greater efficiency in

    terms of reduced costs and greater reliability through lower customer returns, which Auroras

    management had been requesting over years. Products manufactured through this new machine

    will command 10% premium pricing over the current yarn selling rate at $1.0235. The new

    facility will cost $8.05 million in addition to $0.2 million as installation cost. It will have an

    economic life of 10 years and will be depreciated (straight-line) to zero value by then but will

    fetch a salvage value of $100,000. Besides, the facility would reduce sales volume by 5%

    whereas the customer returns cost would be higher because of higher margin products being

    produced by the machine and hence per return cost goes up. However customer returns in

    volume terms to reduce from existing 1.5% to 1.0%. Cost already spend by the management on

    marketing research at $15,000 and $5,000 on engineering are the sunk cost and will be excluded

    from feasibility test.

    There will be no change in direct raw material cost due to consideration of Zinser 351.

    However, the cost of customer return will increase from $0.077 per pound to $0.084 per pound.

    Conversion cost will see no major change except savings on power and maintenance cost to the

    extent of $0.03 per pound. SG&A cost will continue to remain at 7% of sales. In addition, one-

    time cost on machine operator training for Zinser 351 would be incurred in the year of

    installation which is estimated at $50,000. This is important to note that all these cost are with

    reference to current year 2002. Cost and revenue inflation will be 1% p.a. whereas the volume

    growth which is aligned to U.S textile industry volume growth is pegged at 2% p.a. Inventory

    days would be reduced to 20 days from existing 30 days of cost of good sold.
    About existing Hunter Facility

    Existing Hunter facility can be sold at current rate of $500,000 for use in Mexico.

    However if it is not sold today, the same will be depreciated in four years and will fetch no

    salvage value. If proper maintenance given to existing facility, operating at 500,000 pounds per

    week, it can continue for 10 more years and the volume is expected to grow at 2% p.a. before it

    reaches its peak capacity at 600,000 pounds per week after 10 years.

    Other Details

    Aurora Textile marginal tax rate was 36% p.a whereas the hurdle rate for making new

    investment for the management is 10% p.a.

    Major assumptions

    Parameters Existing Zinser 351


    Capacity Volume in 2002 - 500,000 pounds per week 5% lower
    Annual rise 2% p.a. up to 600,000 by 2012
    Annual volume growth 2% 2%
    Annual revenue and cost inflation 1% 1%
    Price ($ / Pound) $1.0235 $1.1259
    Direct Material Cost ($ / Pound) $0.4500 $0.4500
    Conversion Cost (excl. customer returns - $ / Pound) $0.3530 $0.3230
    Customer Returns ($ / Pound) $0.0770 $0.0840
    SG&A Cost (% of Sales) 7% 7%
    Depreciation $500,000 $825,000
    (old machine for 4 years)
    (new machine for 10 years)
    Cash flow from Existing facility
    Particulars 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
    Annual Volume Growth 2% 2% 2% 2% 2% 2% 2% 2% 2% 2%
    Annual Inflation 1% 1% 1% 1% 1% 1% 1% 1% 1% 1%
    Weekly volume (Pounds) 500,000 510,000 520,200 530,604 541,216 552,040 563,081 574,343 585,830 597,546 600,000
    Annual Volume (Pounds) 26,000,000 26,520,000 27,050,400 27,591,408 28,143,236 28,706,101 29,280,223 29,865,827 30,463,144 31,072,407 31,200,000
    Price ($ / Pound) $ 1.0235 $ 1.0337 $ 1.0441 $ 1.0545 $ 1.0651 $ 1.0757 $ 1.0865 $ 1.0973 $ 1.1083 $ 1.1194 $ 1.1306
    Revenues $ 26,611,000 $ 27,414,652 $ 28,242,575 $ 29,095,500 $ 29,974,185 $ 30,879,405 $ 31,811,963 $ 32,772,684 $ 33,762,419 $ 34,782,044 $ 35,274,119

    Direct Material Cost ($ / Pound) $ 0.4500 $ 0.4545 $ 0.4590 $ 0.4636 $ 0.4683 $ 0.4730 $ 0.4777 $ 0.4825 $ 0.4873 $ 0.4922 $ 0.4971
    Conversion Cost ($ / Pound) $ 0.3530 $ 0.3565 $ 0.3601 $ 0.3637 $ 0.3673 $ 0.3710 $ 0.3747 $ 0.3785 $ 0.3822 $ 0.3861 $ 0.3899
    Customer Returns ($ / Pound) $ 0.0770 $ 0.0778 $ 0.0785 $ 0.0793 $ 0.0801 $ 0.0809 $ 0.0817 $ 0.0826 $ 0.0834 $ 0.0842 $ 0.0851
    Total Direct Cost / COGS ($ / Pound) $ 0.8800 $ 0.8888 $ 0.8977 $ 0.9067 $ 0.9157 $ 0.9249 $ 0.9341 $ 0.9435 $ 0.9529 $ 0.9624 $ 0.9721

    Total Direct Cost $ (22,880,000) $ (23,570,976) $ (24,282,819) $ (25,016,161) $ (25,771,649) $ (26,549,952) $ (27,351,761) $ (28,177,784) $ (29,028,753) $ (29,905,422) $ (30,328,505)
    SG&A Cost @ 7% of Sales $ (1,862,770) $ (1,919,026) $ (1,976,980) $ (2,036,685) $ (2,098,193) $ (2,161,558) $ (2,226,837) $ (2,294,088) $ (2,363,369) $ (2,434,743) $ (2,469,188)
    Depreciation $ (500,000) $ (500,000) $ (500,000) $ - $ - $ - $ - $ - $ - $ -

    Operating Income $ 1,424,651 $ 1,482,775 $ 1,542,655 $ 2,104,343 $ 2,167,894 $ 2,233,365 $ 2,300,812 $ 2,370,297 $ 2,441,880 $ 2,476,426
    Less: Taxes @ 36% $ (512,874) $ (533,799) $ (555,356) $ (757,563) $ (780,442) $ (804,011) $ (828,292) $ (853,307) $ (879,077) $ (891,513)
    Post-tax operating profit $ 911,776 $ 948,976 $ 987,299 $ 1,346,780 $ 1,387,452 $ 1,429,353 $ 1,472,520 $ 1,516,990 $ 1,562,803 $ 1,584,913
    Add: Depreciation $ 500,000 $ 500,000 $ 500,000 $ - $ - $ - $ - $ - $ - $ -
    Operating Cash Flow $ 1,411,776 $ 1,448,976 $ 1,487,299 $ 1,346,780 $ 1,387,452 $ 1,429,353 $ 1,472,520 $ 1,516,990 $ 1,562,803 $ 1,584,913
    Less: investment in inventory $ (56,793) $ (58,508) $ (60,275) $ (62,095) $ (63,970) $ (65,902) $ (67,892) $ (69,943) $ (72,055) $ (34,774)
    Free Cash Flow to Firm $ 1,354,984 $ 1,390,468 $ 1,427,024 $ 1,284,685 $ 1,323,482 $ 1,363,451 $ 1,404,627 $ 1,447,047 $ 1,490,748 $ 1,550,139

    Days in inventory 30 30 30 30 30 30 30 30 30 30 30
    Inventory (Direct Cost or COGS * Days $ 1,880,548 $ 1,937,340 $ 1,995,848 $ 2,056,123 $ 2,118,218 $ 2,182,188 $ 2,248,090 $ 2,315,982 $ 2,385,925 $ 2,457,980 $ 2,492,754
    in inventory / 365)
    Investment in Inventory $ (56,793) $ (58,508) $ (60,275) $ (62,095) $ (63,970) $ (65,902) $ (67,892) $ (69,943) $ (72,055) $ (34,774)
    Cash Flow from New Machine Zinser 351
    Particulars 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
    Annual Volume Growth 2% 2% 2% 2% 2% 2% 2% 2% 2% 2%
    Annual Inflation 1% 1% 1% 1% 1% 1% 1% 1% 1% 1%
    Weekly volume (Pounds) 484,500 494,190 504,074 514,155 524,438 534,927 545,626 556,538 567,669 570,000
    Annual Volume (Pounds) 25,194,000 25,697,880 26,211,838 26,736,074 27,270,796 27,816,212 28,372,536 28,939,987 29,518,786 29,640,000
    Price ($ / Pound) $ 1.1259 $ 1.1371 $ 1.1485 $ 1.1600 $ 1.1716 $ 1.1833 $ 1.1951 $ 1.2071 $ 1.2191 $ 1.2313 $ 1.2436
    Revenues $ 28,648,312 $ 29,513,491 $ 30,404,798 $ 31,323,023 $ 32,268,978 $ 33,243,501 $ 34,247,455 $ 35,281,728 $ 36,347,236 $ 36,861,455

    Direct Material Cost ($ / Pound) $ 0.4500 $ 0.4545 $ 0.4590 $ 0.4636 $ 0.4683 $ 0.4730 $ 0.4777 $ 0.4825 $ 0.4873 $ 0.4922 $ 0.4971
    Conversion Cost ($ / Pound) $ 0.3230 $ 0.3262 $ 0.3295 $ 0.3328 $ 0.3361 $ 0.3395 $ 0.3429 $ 0.3463 $ 0.3498 $ 0.3533 $ 0.3568
    Customer Returns ($ / Pound) $ 0.0840 $ 0.0848 $ 0.0857 $ 0.0865 $ 0.0874 $ 0.0883 $ 0.0892 $ 0.0901 $ 0.0910 $ 0.0919 $ 0.0928
    Total Direct Cost / COGS ($ / Pound) $ 0.8570 $ 0.8656 $ 0.8742 $ 0.8830 $ 0.8918 $ 0.9007 $ 0.9097 $ 0.9188 $ 0.9280 $ 0.9373 $ 0.9467

    Total Direct Cost $ (21,807,171) $ (22,465,747) $ (23,144,213) $ (23,843,168) $ (24,563,232) $ (25,305,041) $ (26,069,253) $ (26,856,545) $ (27,667,613) $ (28,059,037)
    SG&A Cost @ 7% of Sales $ (2,005,382) $ (2,065,944) $ (2,128,336) $ (2,192,612) $ (2,258,828) $ (2,327,045) $ (2,397,322) $ (2,469,721) $ (2,544,307) $ (2,580,302)
    Depreciation $ (825,000) $ (825,000) $ (825,000) $ (825,000) $ (825,000) $ (825,000) $ (825,000) $ (825,000) $ (825,000) $ (825,000)

    Operating Income $ 4,010,759 $ 4,156,799 $ 4,307,249 $ 4,462,243 $ 4,621,918 $ 4,786,415 $ 4,955,880 $ 5,130,462 $ 5,310,317 $ 5,397,116
    Less: Taxes @ 36% $ (1,443,873) $ (1,496,448) $ (1,550,610) $ (1,606,408) $ (1,663,891) $ (1,723,109) $ (1,784,117) $ (1,846,966) $ (1,911,714) $ (1,942,962)
    Post-tax operating profit $ 2,566,886 $ 2,660,351 $ 2,756,640 $ 2,855,836 $ 2,958,028 $ 3,063,306 $ 3,171,763 $ 3,283,496 $ 3,398,603 $ 3,454,154
    Add: Depreciation $ 825,000 $ 825,000 $ 825,000 $ 825,000 $ 825,000 $ 825,000 $ 825,000 $ 825,000 $ 825,000 $ 825,000
    Operating Cash Flow $ 3,391,886 $ 3,485,351 $ 3,581,640 $ 3,680,836 $ 3,783,028 $ 3,888,306 $ 3,996,763 $ 4,108,496 $ 4,223,603 $ 4,279,154
    Less: investment in inventory $ 685,634 $ (36,086) $ (37,176) $ (38,299) $ (39,456) $ (40,647) $ (41,875) $ (43,139) $ (44,442) $ (21,448)
    Free Cash Flow to Firm $ 4,077,520 $ 3,449,265 $ 3,544,463 $ 3,642,537 $ 3,743,572 $ 3,847,659 $ 3,954,888 $ 4,065,357 $ 4,179,161 $ 4,257,706

    Days in inventory 20 20 20 20 20 20 20 20 20 20
    Inventory (Direct Cost or COGS * Days $ 1,880,548 $ 1,194,913 $ 1,231,000 $ 1,268,176 $ 1,306,475 $ 1,345,930 $ 1,386,578 $ 1,428,452 $ 1,471,592 $ 1,516,034 $ 1,537,481
    in inventory / 365)
    Investment in Inventory $ 685,634 $ (36,086) $ (37,176) $ (38,299) $ (39,456) $ (40,647) $ (41,875) $ (43,139) $ (44,442) $ (21,448)
    Evaluation
    Particulars 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
    FCF from Existing Machine $ 1,354,984 $ 1,390,468 $ 1,427,024 $ 1,284,685 $ 1,323,482 $ 1,363,451 $ 1,404,627 $ 1,447,047 $ 1,490,748 $ 1,550,139
    FCF from Zinser 351 $ 4,077,520 $ 3,449,265 $ 3,544,463 $ 3,642,537 $ 3,743,572 $ 3,847,659 $ 3,954,888 $ 4,065,357 $ 4,179,161 $ 4,257,706

    Incremental FCF from Zinser 351 $ 2,722,537 $ 2,058,797 $ 2,117,439 $ 2,357,852 $ 2,420,090 $ 2,484,207 $ 2,550,261 $ 2,618,309 $ 2,688,413 $ 2,707,568
    Initial Cost $ (7,242,000)
    Post-tax sale value of Zinser 351 $ 64,000
    Net FCF from Zinser 351 $ (7,242,000) $ 2,722,537 $ 2,058,797 $ 2,117,439 $ 2,357,852 $ 2,420,090 $ 2,484,207 $ 2,550,261 $ 2,618,309 $ 2,688,413 $ 2,771,568
    NPV $ 7,779,639
    IRR 31.04%

    Initial Cost Value


    Machine Cost $ (8,050,000)
    Installation Cost $ (200,000)
    Total Machine Cost $ (8,250,000)
    Sale Value of old machine $ 500,000
    Add: Tax saving on sale below book value of
    $2,000,000 $ 540,000
    Less: post-tax training cost ($50,000*64%) $ (32,000)
    Net Initial Cost $ (7,242,000)

    Recommendations

    The above analysis shows that the new machine would deliver substantial positive NPV and an IRR of 31.04% which is very high

    compared to required hurdle rate of 10% and hence makes every sense for the management to go ahead and replace existing facility

    with new Zinser 351.

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