Case 20: Aurora Textile Company
In early 2003, Michael, CFO of Aurora Textile Company, is deciding whether or not to install a new machine called Zinser 351 in order to save the declined sales and increase its competitive force. In deciding whether or not to invest Zinser 351, it is important to get the NPV and the payback period. To get the NPV and the payback period, we firstly need to forecast the future cash flows that the new machine will generate. We found the ten-year NPV to be $3,171,551 based on the FCFs that we forecast. Also, we use the payback period to analyze the acceptance of this project. We found that the discounted payback period is 5.69, which is less than the arbitrary cutoff point of 7.87. Based on our forecast, the company should invest in the Zinser 351 because of the positive NPV and relatively small payback period Body:
In our analysis, we determined that NPV is the most important factor determining if we should accept or reject the Zinser 351 project. Secondly, we established that the payback period is another contributing force in our decision. The payback period tells us whether we can earn some money in the set period of time but this model has a few drawbacks, such as ignoring timing of cash flows and the positive cash flow after the payback period. In both calculations, NPV and payback period, we forecasted future cash flows (free cash flow).
In order to forecast the free cash flow for the next ten years, we needed to first predict the operating cash flows—By adding EBIT to depreciation, less tax. To predict the next ten years of EBIT, we needed the proper sales figures, which we calculated by multiplying volume by sales price. According to our spreadsheet, the sales price is $1. 1259 and we assume volume to decrease at a rate of 95 percent of the expected volume without Zinser per year—(95% of 120,000). After calculating the operating cash flow for the next ten years, we needed to find estimated FCF (Free Cash...
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