Aurora Textile Case
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TABLE OF CONTENTSCase Context Case assumptions General Sales volume and cost projections Option 1: Existing Ring Machine Option 2: Zinser 351 Inventory projections Analysis Framework for Analysis Discounted Cash Flow Analysis Option 1: Existing Ring Machine Option 2: Zinser 351 Decision To replace or not When to replace Risks and recommendations Risks Source of funding Effect of price cut Other risks Recommendations Management Actions Invest or Pay Dividends Case ContextEstablished in the 1900s, Aurora Textile Co. (“Aurora” or “Company”) is one of the oldest yarn manufacturers in the United States, with operations spanning domestically and across the globe. Major apparel and industrial good manufacturers are the company’s main customers. In particular, Aurora caters to four major customer segments. This is presented in Table 1.1 below. It can be noted that almost 80% of Aurora’s revenue come from the Hosier and Knitted Outerwear segments.Customer Segment% of RevenueDescriptionHosier43%Dominates this market segmentLittle competition from rivalsEnjoys attractive marginsKnitted Outerwear35%Little product differentiationFierce competition from rivalsSuffers price compressionWovens13%Cost efficient to produceGreat growth opportunityIndustrial & Specialty9%Enjoys highest marginsGreat growth opportunityTable 1.1 Customer Segments of AuroraDuring the past couple of years, the US textile-mill industry suffered from a huge drop of demand for its products. This forced Aurora to retain only four of its facilities to reduce manufacturing costs so that the company can continue its operations. The major causes for the decline of the US textile-mill industry are described in Table 1.2 below.CauseEffectGlobalizationSome firms shifted operations to Asia due to lower production costsTougher competition due to imported yarnConsumer preferences and fadsShift to flexible manufacturingEnabled apparel producers to bring goods to customers in a shorter timeImprovement in ITLiability associated with customer returns increasedTrade policiesFree trade agreements worsened US textile environment due to cheaper labor, lower quality of products, and government subsidy. Ban of quotas to take effect on 2005 which could add to industry woes.Table 1.2 Factors that Contributed to the Decline of the US Textile Industry
The four plants of Aurora that remain in operation are Hunter, Rome, Barton, and Butler. Aurora relies on the rotor spinning technology to manufacture its yarns in the Rome, Barton and Butler plants. Only the Hunter plant makes use of the ring spinning technology. Table 1.3 shows the main differences between the rotor and ring spinning technologies. In a nutshell, the former focuses on efficiency while the latter technology focuses on the quality of the yarn being developed.RingRotorBetter qualityStronger yarnMore efficientLess expensiveTable 1.3 Advantages of the Rotor and Ring Spinning TechnologiesIn order to remain competitive, a project was initiated to update the ring technology in the Hunter plant to increase its efficiency. The Chief Financial Officer (CFO) of Aurora is evaluating two possible options: to continue using the current ring technology machine or replace it with the more efficient Zinser 351 technology. Table 1.4 summarizes the main financial considerations when choosing from the aforementioned options.Current Ring MachineZinser 351Book Value of $ 2 millionDepreciated to 0 for 4 yearsSalvage Value of $ 500,000 todayCan operate for 10 more yearsConversion cost at $0.43/lbCustomer returns constitutes $0.077/lbSG&A expenses at 7% of the revenuesCotton inventories at 30 daysCost of $ 8.25 millionDepreciated to 0 for 10 yearsSalvage Value of $ 100,000 at year 10One-time training cost of $ 50,000Conversion cost at $0.40/lbCustomer returns constitutes $0.084/lbSG&A expenses at 7% of the revenues10% higher sales price5% lower sales volumeCotton inventories at 20 daysTable 1.4 Main financial considerations of the two optionsThe primary advantage of Zinser 351 is its ability to produce higher quality and higher margin products. The efficiency of the new technology would also reduce operating costs by $ 0.03 lb. On the other hand, the primary disadvantage of Zinser 351 is that, compared to the existing ring technology, the company will generate a 5% lower revenue as well as shoulder higher customer liabilities from returns. In addition to that, a huge investment is necessary for Zinser 351 to operate. Given these inputs, the CFO must decide which between these two options is better, given that both options have its costs and benefits.