Aurora Textile Company Case Study

Aurora Textile Company

Introduction:

Aurora Textile Company was a yarn manufacturer established in the early 1900s, and 90% of the company's revenue came from the domestic textile market. Aurora serviced four major customer segments: 1). Hosiery, accounted for 43% of Aurora's revenue. The primary consumer products were athletic and dress socks, and Aurora was the largest volume producer of all cotton yarns for white athletic socks in the U.S.; 2). Knitted outerwear, the second-largest revenue source for Aurora, accounted for 35% of revenue; 3). Wovens, a small (13%) but important segment for the company, was believed to be a great market to find growth opportunities; 4). Industrial and specialty products, the smallest segment, it provided the highest margins for Aurora.

Although Aurora was the leader in textile-mill industry, the company and the whole industry were in a crisis situation because of globalization, and cheaper production costs overseas. Since textile-mill was a labor-intensive industry, in more recent years, the search for cheaper production costs had begun to move the textile-mill industry to Asia. Secondly, the strong U.S. dollar had made foreign textile manufacturers products much cheaper than those from U.S. companies. In addition, the World Trade Organization recently had announced that it would ban its members from using quotas, which would further open the U.S. market to competition from other countries.

So how would Aurora face the crisis, since its sales have decreased four years in row, and its price fell from $30 per share to $12 per share, how would Aurora solve its problems? Zinser 351, a new ring-spinning machine, was under considered by the management of Aurora. Was it a good investment and could it save Aurora?

Analysis:

(1). Kept using existing machine

If Aurora kept using existing machine, let's assume that 1). The average raw material cost, the selling price, and the cost of customer returns would keep the same level with 2002 for the next ten years; 2). SG&A expenses were estimated to remain at 7% of revenues; 3). Every year the depreciation of the existing machine was $0.2 million from 2003 to 2006, and 0 after 2006; 4). Interest expenses, other income (expense), and asset impairments were 0 from 2003 to 2012. 5). its production level was 600,000 pounds a week and 31,200,000 pounds per year.

Based on those assumptions above, we estimated that the existing machine would bring $1.3 million each year from 2003 to 2006, and $1.4 million each year after that. Its NPV would be $8.35 million (see table 1).

(2). Purchased Zinser 351

There were pros and cons of installing Zinser 351. First, it could produce a finer-quality yarn that would be sold in a niche market in a higher price (10% higher than the current price, 1.0235*1.1=1.126), but its installation cost was 8.25 million dollars. Aurora have had negative net earnings four years in row, and its cash and cash equivalents at the end of 2002 was less the 2 million. Considering its credit rating of BB, it was very costly for Aurora to borrow money to purchase Zinser 351. Secondly, Zinser 351 could increase efficiency, and reduce operating costs, but it would also cause 5% lower sale volume. Thirdly, Zinser 351 had greater reliability than current machine, but it would also cause higher customer returns cost.

If Aurora purchased Zinser 351, let's assume that 1). Zinser 351's production level was 500,000 pounds a week and 26,000,000 pounds per year; 2). The average raw material cost would keep the same level with 2002 for the next ten years; 3). The cost of customer returns increased $0.007/lb ($0.084/lb - $0.077/lb), so the conversion cost would become 0.4366/lb; 4). The selling price would increase 10% and become 1.1259/lb; 5). SG&A expenses were estimated to remain at 7% of revenues; 6). Every year the depreciation of Zinser 351 was $0.825