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Aurora Case

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Q.1

The Textile-Mill Industry is a term associated with industries that are primarily concerned with the design and manufacturing of clothing as well as the distribution and use of textiles. The industry can be split up into three stages: Cotton stage, industrial revolution, and post industrial revolution.

In the early parts of the Textile-Mill Industry, known as the cotton stage, products were produced at home using wool, cotton, or flax depending on the area and location. The excess material was sold to merchants called clothiers who would visit the villages and buy large amounts of excess cloth from local producers. The process for making cloth involved three steps which included preparation of fibers for spinning, spinning, and weaving or knitting. In the early days everything was very labor intensive and the market was limited to local towns and passing clothiers.

The second stage of the Textile-Mill Industry is known as the industrial revolution stage. During this period mass production of clothing became a mainstream industry which resulted in a growth of the entire Textile-Mill Industry. The spinning and weaving process became mechanized with several new machines introduced to the industry with the majority of the power coming from water wheels. Additionally, the industries market began to expand as exports of textiles began to rise.

Presently the Textile-Mill Industry is situated at the third stage known as the post industrial revolution stage. In the current stage the industry has experienced dramatic globalization, new trade policies, cheaper production cost, and new customer preferences.

Globalization has drastically changed the Textile-Mill Industry as the transformation of regional economies, societies, and cultures have become integrated through a worldwide network of communication and trade. Globalization is a result of textile manufacturers looking for cheaper production cost involved with cheaper labor and cheaper raw material cost.

Trade policy has also change the Textile-Mill Industry, specifically in the United States, creating a burden on the industry by encouraging trade with Canada, Mexico, and Caribbean Countries which have lowered the prices of consumers’ goods in the United States. These new trade policies mean that United States based companies now have to compete with companies based outside the United States that have cheaper labor, lower environmental standards, and government subsidized operations. These changes are a result of trade agreements like the North America Free Trade Agreement (NAFTA) and the Caribbean Basin Initiative (CBI).

In addition to United States based companies competing with North American companies they must also compete with companies from Asia and Europe. This means that they must compete against similar characteristics of North American companies like cheaper labor, lower environmental standards, and government subsidized operations. In the past the United States have used tariffs and quotas as a mechanism to prevent the influx of foreign goods into the United States thus protecting the domestic industry.

Throughout the years we have seen the Textile-Mills Industry change from a localized industry in the cotton stage to a globalized industry in the post industrial revolution stage of today. This has resulted in United States companies having to compete with other countries that are playing under different rules. With companies continuing to strive for better more efficient productions, globalization will continue to challenge United States based companies to re-evaluate their productions and figure out how to compete with the rest of the world.

Q2.

In this case, we tried to forecast for the two projects: keeping existing machine, and replacing it by new machine-----Zinser. From 2003’s forecasting, we separate the existing machine and the new machine from the other three plants, for example, the Net Sales from 2003 to 2012 only shows the sales for the existing machine or the new machine. And the hidden assumptions that we made for calculating free cash flow are as follows: ➢ The existing machine production capacity grows in a straight-line from 500,000/week to 600,000/week for ten years. ➢ The sales of the new machine will be 5% less than the existing machine from 2003 to 2012. ➢ The new machine’s production capacity will be equal to the existing machine with higher quality. ➢ The sales volume = existing machine production capacity. ➢ From 2005, the selling price of the product will stay the same because of NAFTA and WTO. ➢ In the analysis for both projects, we ignored the effect of the inflation in price and cost, because it will affect those projects in the same way. ➢ The percentage of the A/R and A/P would be the average percentage of the past four years. ➢ We assume that the company did not distribute dividends to shareholders during the past years.
After we calculate the NPV of the existing machine, we find out that if we keep using the existing machine, the NPV would be negative (-$5,974.8595), which means the project’s cash flows are not sufficient to repay the invested capital and to provide the required rate of return on that capital. For the second project, if we replace the existing machine with the new one---Zinser, then we can see that the NPV would be $11,290.23. Obviously, the installation of new machine can generate profits for the company. Additionally, the IRR (83%), which is greater than cost of capital (2.17%), confirmed that taking on the project can increase shareholders’ wealth. And it will take within one year for the company to get the investment back. The profitability index would be around 4. Therefore, from all those numbers and ratios, we can see that the new machine could generate a lot more profits for the company, so it would be much better for the company to replace the existing machine by the new one.

3.

Aurora Textile Company must evaluate whether it is in the shareholders best interest to makes changes within the company at a time where the Textile-Mill Industry is drastically changing. Some of the major factors affecting the Textile-Mill Industry is the removal of The Agreement on Textiles and Clothing (ATC) as well as increase liability risks associated with customer returns.

The World Trade Organization’s website states the following regarding textile trade:

“The Agreement on Textiles and Clothing (ATC) and all restrictions there under terminated on January 1, 2005. The expiry of the ten-year transition period of ATC implementation means that trade in textile and clothing products is no longer subject to quotas under a special regime outside normal WTO/GATT rules but is now governed by the general rules and disciplines embodied in the multilateral trading system.”

This end of this agreement means that exporting countries will not longer have the burden of quotas thus opening big opportunities worldwide. Being that the ATC will end January 1, 2005 the Aurora Textile Company still has time to capitalize on the restriction of trade by the WTO. Improving their equipment now is critical for the company to gain an edge by positioning themselves to match competitors from countries that have cheaper labor, lower environmental standards, and government subsidized operations. Based on our calculations the new machines has a payback on less than one year which is long before the ATC will expire.

Regarding the increase liability risk associated with customer returns Aurora Textile Company will benefit from introducing the new machine. Since the new machine will produce higher quality yarn the customer returns will decrease from 1.5% to 1.0%. Although the new machine will be producing higher quality yarn that will be sold at higher end retailers like Nordstrom, the liability will increase as well. This means that if the old machines yarn was being sold to produce shirt valued at $25 the new machine will sell yarn that will produce shirts that will be selling at $75. The difference in price and the decrease in returns will result a returns as cost/lb of $0.077 for the existing machine and $0.084 for the new machine. Although the new machines cost of returns is higher per pound, this is not the only factor to be considered. The fact that the new Machine will produce yarn for higher quality products that will eventually be sold at higher end retailers means that it is opening up an additional segment of customers for Aurora Textile Company.

Since the company has only two years before the ATC ends it is in the companies shareholders best interest to purchase the new machine because it will give them a head start before directly competing with companies world wide and it will also open it new segments of the market by producing higher quality yarn.…...

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