Company is currently not in very good financial situation. Based on calculations that I made for the capital budgeting, my recommendation is to buy the new Zinser machine. After computing the NPV for the project it came out to be $10,160,579 over the period of 10 years. According on the analysis of the CFO of the company, Zinser would produce a finer- quality yarn that would be used for higher quality and higher margin products.
Since Aurora has been facing so many financial challenges over the years, implementing a new system in place would be a good strategic investment, since their stock price has dropped significantly from $30 to $12. The decision makers of the company need to look at the fact that installing Zinser wouldn’t cost them anything in work force and it is predicted to reduce power and maintenance costs by 0. 03 per pound. Based on these assumptions the cost of customer returns will also be higher, which will result in higher profits.
With the increasing global competition in mind, Aurora needs to switch to the new Zinser system if they want to remain competitive on the market and keep shareholders confidence. II. Statement of the Problem The Chief Financial Officer, Michael Pogonowski needs to decide whether the company should purchase the new machine Zinser or keep using the existing ring-spinning machine. He also needs to figure out how to improve the company’s overall financial situation and regain shareholders confidence.
III Analysis of the Problem Aurora is facing a lot of financial challenges as seen in the statement of the problem. When you look at the back of this report you will find Exhibits that outline the computations that helped me in making the decision that purchasing Zinser is the best out of the two options. In order to complete the calculations there were a number of assumptions that I had to make to work out the problem. I assumed that the industry average would be 2% and the inflation would be 3%.
We used 2% industry growth to calculate the sales volume by multiplying by 1. 2. We used inflation of 3% to calculate the increase in selling price, the cost of raw materials over the years, conversion costand SG &A costs. For the hurdle rate I made an assumption to use 15%, since there wasn’t enough information provided to calculate the hurdle rate in the case. My assumption was based on industry average for textile market of 11. 3% and 6. 90% BB bonds rate. I also assumed that the tax rate, SG& and material costs remained constant over the years.
For the capital budgeting calculation I had to compute the values for the old machine and then for the old machine and finally the changes between the two options. The assumption that was provided in the book that hurdle rate is supposed to be 10% is incorrect because it is less then the industry average, thus the numbers that the company would receive for the NPV would be skewed. Some of the differences in the calculations that stood out to me are that we see a decrease of the raw materials costs if we use Zinser.
For example if we use old machine the cost of raw materials in 2003 would be $12,316,604, while if the company switches to using Zinser the cost goes down to $11,700,773. We also see that even though the company would incur some large costs in the first years such as R& D and training, making the net income drops in the first year, over the course of 10 years the net income if we use Zinser grows exponentially. The comparison between the old and new machine shows that in the long-term Zinser proves to save costs and raise capital for the company.
We can see this information before the calculation of the NPV. When it comes to fixing the overall financial health of the problem, there is no easy answer to fix the problem. After the company decides to install Zinser system they can prove to the investors and shareholders that based on the financial projects this will benefit the company and shareholders in the long run. At this point Aurora needs to focus on its process to improve efficiency and start paying off some of its long-term debt.
Looking at 2002 their long-term debt was $58,000, while and the equity was $47,543. This is a huge red flag that the company is going through some struggles when its debt is significantly higher then its equity. With implementing Zinser and focusing on improving the relationships with investors and shareholders, Aurora will see the increase in its stock price, while will further lead to increase in the equity, which will hopefully stabilize the overall financial position of the company.