Aurora Textiles has historically been one of the premier textile companies in the United States and now has a decision to make. With the opportunity to invest in equipment that could help cure our slumping financials, we must carefully explore whether this investment is appropriate for a company with such an uncertain future. With that in mind we believe that the Zinser 351 is the perfect investment to pull us out of this slump. As a company that has been able to deliver a premium product for the consumers, the Zinser 351 will allow us to continue to do that while also begin relieving some of the financial stress that we have been under.
Our analysis shows that the Zinser 351 project will yield a Net Present Value of $6,474,082. 14 million and a discounted payback period of 5. 6 years. This project not only brings a big enough payoff as demonstrated by the NPV, but also fits our timeline. The discounted payback period indicates that our investment will be realized before our company is not able to recover from our current financial struggles. The Zinser 351 is a project that this company must undertake if it wants to begin to bring value back to the shareholders who have become more and more impatient with us in recent times.
This is an opportunity for Aurora to turn around its fortunes and once again prove that it is the premier textile company in the United States. When deciding whether the Zinser is a worthwhile investment or not, we will analyze the decision like we would any other investment decision. Finding the net present value of the project will ensure that the project will have large enough cash flows to clear out 10% hurdle rate. When calculating the NPV of the project we discovered that investing in the Zinser will yield a positive NPV of $6,350,623. 23. This is the first strong signal that the Zinser is a good investment for Aurora.
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Since the project presents a positive NPV, we can now look deeper into how we arrive at that number and also address any concerns that come up with the project that may not be considered in the NPV. The first of these concerns would be the financial situation of Aurora Textiles as a whole. We have historically been a very strong company who has been seen as one of the premier companies in the textile industry. As of late we have posted less than stellar numbers though. In each of the last four years, we have posted negative net earnings. This is troubling and if this continues it could lead to us having to liquidate the company.
With the current cash burn rate that we are on, our company will be bankrupt in 7. 86 years. When evaluating the Zinser project we will look at this as the tentative cutoff date for when we can realize the cash flows for this project. Although we have been struggling financially and have an approaching timeline for turning the company around, we find that this only gives us more of an urgency to invest in the Zinser. First of all, when looking at the discounted payback period for the project, we have discounted back the cash flows for the project and found that the current payback period is 4. 07 years.
This is encouraging as it is well before the 7. 86 year deadline we are on. Having a relatively small payback period is important to us because of the struggles we have had lately. Since this project fits our time horizon, we can look at what this project will do for our company. The Zinser project will allow our operations in the Hunter location to become more efficient while widening our profit margins. The Zinser machine will actually decrease the volume produced and the volume of sales. This is not of much concern though because our sales revenue will increase.
The projected numbers show that if we invest in the Zinser 351, next year already we will see an increase of $1. 2 million. This is possible because the Zinser allows us to produce higher quality threads which in turn, create higher margins. Our projections have this increase in gross margins at almost $3 million next year. We believe this is important to Aurora Textiles because in the past we have been considered a premium-quality company, and it is widely known that our largest market, the hosiery market, is moving towards a larger demand for higher quality products instead of the cheaper, lower-quality products.
This market accounts for 43% of our revenue and investing in a project that improves our place in this market can only be a positive. It is also worth noting that the hosiery market is considered the most protected against global competition because of the high transport costs and heavy usage of automated labor. With the ban being lifted on quotas in 2005 this positioning in a global-protected market is not to be overlooked.
With the industry as whole looking at depressed forecasted growth in the near future, it puts more emphasis on our ability to become as efficient as possible so that we are able to stay ahead of our competitors and turn around our financial troubles. Since we have already closed some of the more inefficient factories, we can consider this the beginning of refocusing on our core operation. If we invest in the Zinser 351, there is no reason to believe that our financials will not begin to improve. Our sales revenue will improve and our margins will widen. This project will also begin producing cash flows for us immediately.
It is our opinion that this project can be nothing but beneficial for the company and its shareholders. While it can be argued that the Zinser may not be enough to bring this company out of the pitfall that it is facing, doing nothing ensures that the company will not survive. It is important to remember that at the heart of the decision is deciding what will provide the shareholders the most value. We mentioned earlier that the tentative deadline for the company to turn things around would be 7. 86 years. Of course we know that this is only a projection, it is possible that this deadline could be sooner.
With that in mind, we believe the project could break even much earlier than the 4. 07 years calculated by using the discounted payback period if necessary. After operating for two years, the Zinser 351 would only have to resell for 48. 6% of its original value to hit the breakeven point when you factor in the cash flows from those two years. While it is not our intention, nor our belief, that this project will be that short sighted, it is important to look at the worst case scenario in every situation. The last issue that needs to be looked at is how our projections may hold up.
While it looks as though the Zinser machine will immediately begin improving our operations, we can look at some of the assumptions that had to be made to analyze the project. When analyzing the data it becomes quickly apparent that the biggest assumption that affects the NPV of the Zinser project is the product return rate. With the old machine we allowed for a return rate of 1. 5%. It is assumed that because the Zinser will produce a much higher quality that the return rate will drop to 1%. When considering all possible outcomes for what may actually be the return rate when production begins, NPV starts to vary greatly.
To illustrate, if our return rate happens to be just 0. 2% lower than projected, that turns out to be almost a $2 million increase in NPV. On the other hand if our return rate was 0. 2% higher, NPV would shrink to $4. 6 million instead of $6. 35 million. While this may raise some concerns on how accurately we can project NPV, there is some good news. When examining other assumption made in our NPV calculations, the two other main assumptions made, sales and volume growth, had little effect on the overall NPV. In both cases even a 2% swing either way would not affect the NPV more than a couple thousand dollars.
This is good news because it allows us to realize what our focus should be when trying to maximize NPV. By examining the effects our assumptions have on NPV, we realize that a key factor in investing in the Zinser 351 is not one of increasing sales or producing more, but it is an issue of quality control. This reveals that this project creates a synergy between our goals and what this machine will allow us to do. As a company that is looking to reposition itself as a company producing high quality products at higher margins, the Zinser project will drive us to reach our goal.
Because we are in an industry that does not have optimistic growth projections, it is positive to see that our sales and volume growth will not be as big of a factor on the NPV of this project. The Zinser 351 is essentially a project that is fit to be more economically inelastic but more elastic to the internal operations of the company. If Aurora is able to optimize its quality control techniques and keep the product return rate at least as low as we have projected, then we will immediately see positive cash flows and will begin the recovery from previous years’ financial distresses.
This project has all the potential to begin to restore the value that shareholders once saw in our company while also being a fairly safe investment. In a cost-benefit analysis, this project seems to be heavily one sided towards the benefit side as cost is relatively small. The Zinser 351 is just what Aurora Textiles needs to pull itself out of the financial hole it has dug itself into and returns itself to being the premium textile manufacturer it once was.
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