Case 20 : Aurora Textile Company
Case 20: Aurora Textile Company
GROUP QUESTIONS
Learning Objectives:
1. The basics of incremental-cash-flow analysis: identifying the cash flows relevant to a capital-investment decision
2. The construction of a side-by-side discounted-cash-flow analysis for a replacement decision
3. How to adapt the NPV decision rule to a troubled industry
4. The recognition that a reduced investment horizon is a significant consequence of financial distress
5. The importance of sensitivity analysis to a capital-investment decision
Case Questions
1. How has Aurora Textile performed over the past four years? Be prepared to provide financial ratios that present a clear picture of Aurora’s financial condition.
From 1999 through 2002, the financial performance of Aurora was unattractive and disheartening. This could be attributed to the business risks that arose from the intense competition that characterizes the industry in which Aurora operates. Absent an industry benchmark or comparable with which to gauge the performance of Aurora, we utilized a trend analysis of the period 1999 through 2002.
With 1999 as a reference point, we noticed that all measures of profitability have worsened. On a cumulative annual basis, net sales have been declining by 15%, while profit margins and ROA were always in the negative (see exhibit 1). While raw material cost as a percentage of net sales have been declining, the cost of conversion is escalating and affecting the bottom-line (see exhibit 1). It is obvious that Aurora needs to manage its expenses to generate profits from sales. While on the surface, the liquidity measures have improved (see exhibit 1), it is doubtful that the company has the ability to meet its current obligations with just cash and cash equivalents on hand. This is partially due to the fact that many of the firm’s current assets are predominantly account receivables and inventories. While it is true that the firm, its competitors, and the industry are
GROUP QUESTIONS
Learning Objectives:
1. The basics of incremental-cash-flow analysis: identifying the cash flows relevant to a capital-investment decision
2. The construction of a side-by-side discounted-cash-flow analysis for a replacement decision
3. How to adapt the NPV decision rule to a troubled industry
4. The recognition that a reduced investment horizon is a significant consequence of financial distress
5. The importance of sensitivity analysis to a capital-investment decision
Case Questions
1. How has Aurora Textile performed over the past four years? Be prepared to provide financial ratios that present a clear picture of Aurora’s financial condition.
From 1999 through 2002, the financial performance of Aurora was unattractive and disheartening. This could be attributed to the business risks that arose from the intense competition that characterizes the industry in which Aurora operates. Absent an industry benchmark or comparable with which to gauge the performance of Aurora, we utilized a trend analysis of the period 1999 through 2002.
With 1999 as a reference point, we noticed that all measures of profitability have worsened. On a cumulative annual basis, net sales have been declining by 15%, while profit margins and ROA were always in the negative (see exhibit 1). While raw material cost as a percentage of net sales have been declining, the cost of conversion is escalating and affecting the bottom-line (see exhibit 1). It is obvious that Aurora needs to manage its expenses to generate profits from sales. While on the surface, the liquidity measures have improved (see exhibit 1), it is doubtful that the company has the ability to meet its current obligations with just cash and cash equivalents on hand. This is partially due to the fact that many of the firm’s current assets are predominantly account receivables and inventories. While it is true that the firm, its competitors, and the industry are