Aurora Textile Case

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Case assumptions

General

- All assumptions of capital budgeting hold.

- All projects have the same degree of risk as the firm overall

- Management must set benchmarks for the evaluation of capital expenditure (e.g., number of years to payback; rate of return etc.)

- The firm’s cost of capital is constant over time and is not affected by the amount of funds invested in capital projects

- Investment opportunities are independent of each other

- Borrowing and lending rates are equal

- Perfect capital markets exist

- The nominal cost of capital is 10%

- The forecasts of the research analyst are accurate.

- On the average, 2% growth in volume.

- On the average, 1% increase in conversion and material costs.

- On the average, 1% increase in the selling price.

- The lifting of the ban of quotas effective 2005 will not drastically affect Aurora’s operations.

- All statistics used are in the case exhibits 1- 7.

- All entries that affect working capital are assumed to be constant for years 1 to 10 except for inventory.

- For the year ending 2002, the assumed Days Sales Inventory is 90 days as confirmed by Hunter’ Plant Manager.

- If Option 1 (retain the existing technology) is chosen, the assumed Days Sales Inventory is 30 days as this will be in line with the industry standards. The plant manager will have no choice but to comply.

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Sales volume and cost projections

Option 1: Existing Ring Machine

Shipping volume (1a) was forecasted to grow from 26,520,000 pounds in 2003 to 31,693,855 pounds in the tenth year based on the assumed 2% real growth of the U.S. textile industry. Average selling prices (1b), average raw-material cost (1c) and conversion costs (1d) per pound―seen to rise by the 1% annual inflation rate―are also projected below. Also, selling, general and administrative expenses (“SG&A”) (1e) are expected to remain at 7% of revenues.

Option 2: Zinser 351

Shipping volume (2a) was forecasted to grow from 25,194,000 pounds in 2003 to 30,109,162 pounds in the tenth year based on the assumed 2% real growth of the U.S. textile industry and 5% decrease in sales volume. Average selling prices (2b), average raw-material cost (2c) and conversion costs (2d) per pound―seen to rise by the 1% annual inflation rate―are also projected below. Furthermore, the conversion costs were calibrated to reflect the savings in power and maintenance costs as well as the increase in the cost of customer returns. Similar to Option 1, SG&A expenses (2e) are expected to remain at 7% of revenues.

Please refer to Tables 2.2 and 2.3 in the subsequent page for the sales volume and cost projections for both options.

Inventory projections

Factoring in the information provided by the Hunter plant manager that about three months (90 days) of cotton are maintained at the plant, the method below was used to come up with an estimate of inventories held as of the end of 2002 (amounts are in thousands, except per-pound figures).

Raw-material and conversion costs per lb.

Pounds shipped

Raw-material and conversion cost

Inventory days (cotton)

Days in a year

Inventory at end of 2002 (cotton)

0.4509+0.4296 = 0.8805

*

26,000

*

(22,893)

*

90

*

360

=

5,723

Table 2.1 Method in computing inventory projections

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Year

0

1

2

3

4

5

6

7

8

9

10

1a

Pounds shipped (in thousands)

26,000

26,520

27,050

27,591

28,143

28,706

29,280

29,866

30,463

31,072

31,694

1b

Average selling price/lb.

1.0235

1.0337

1.0441

1.0545

1.0651