Case 20 : Aurora Textile Company

1564 words 7 pages
Case 20: Aurora Textile Company
GROUP QUESTIONS

Learning Objectives:
1. The basics of incremental-cash-flow analysis: identifying the cash flows relevant to a capital-investment decision
2. The construction of a side-by-side discounted-cash-flow analysis for a replacement decision
3. How to adapt the NPV decision rule to a troubled industry
4. The recognition that a reduced investment horizon is a significant consequence of financial distress
5. The importance of sensitivity analysis to a capital-investment decision

Case Questions

1. How has Aurora Textile performed over the past four years? Be prepared to provide financial ratios that present a clear picture of Aurora’s financial condition.

From 1999 through 2002,
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However, even if Aurora shuts down, the earlier they terminate, the higher the salvage value of the Zinser machine will be. Therefore, the time period to breakeven might be less than 4 years. If the Zinser machine can be sold for its 50% book value at early termination, it only needs 2 years for the project to add value to the Aurora Textile Company.

4. How sensitive is the economic life of the Zinser investment to its value to investors? In other words, if the company survives the entire 10 years, what is the NPV of the project? What if the company can survive only four years, what is the NPV of the project?

For our sensitivity analysis, the main things we focused on were production levels and price. Here is a chart representing the IRRs for certain production levels and prices.

Our production level estimates were based on the fact that we don’t know how the market will react with increased foreign competition. The textile growth rate we used for our most likely model is the domestic rate of growth, not the world growth rate. We don’t know if letting foreign competitors into the market would significantly shift the industry out of America or if it will keep a constant growth (at 2%). Our price estimates were based on the new WTO mandate that is going into effect in 2005. With the tariffs and quotas on the textile industry being lifted, there will be a significant growth in the amount of textile goods

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