Case 20: Aurora Textile Company
In early 2003, Michael, CFO of Aurora Textile Company, is deciding whether or not to install a new machine called Zinser 351 in order to save the declined sales and increase its competitive force. In deciding whether or not to invest Zinser 351, it is important to get the NPV and the payback period. To get the NPV and the payback period, we firstly need to forecast the future cash flows that the new machine will generate. We found the ten-year NPV to be $3,171,551 based on the FCFs that we forecast. Also, we use the payback period to analyze the acceptance of this project. We found that the discounted payback period is 5.69, which is less than the arbitrary cutoff point of 7.87. Based on our …show more content…
Additionally, Zinser can effectively decrease the amount of inventory that we use to run the business in comparison to the old machine. As we know, Zinser can reduce the cotton inventories form 30 days to 20 days—dropping around 714,285.71 pounds of inventory—per month opening the door for roughly $321,428.57 of savings per month. Even though the old plant manager suggests using the cost-minimizing strategy, we suggest to consider the way we mentioned above.
Then, we have determined the company is better off using Zinser because the WTO lifted the ban on quotas in 2005 resulting in increased competition. With the increased competition we will see that the supply of textiles will increase and force downward pressure on prices. Only the companies with high quality products can survive in this intense competition. We believe Zinser makes the company more competitive than those rivals because of the high quality outputs. According the sensitivity analysis, we still retain a positive NPV and relatively small payback period with Zinser, even after a 35% price drop.
Furthermore, using Zinser can dramatically change our company’s outlook because its return as percent of volume is 1% (the return as percent of volume without Zinser is 1.5%). As our sensitivity analysis shows, the NPV with (without) Zinser is $3,171,551