In January 2016, Ravi, the chieffinancial officer of Modern Textiles Company, located in Coimbatore India, wasquestioning whether the company should install a new ringspinning machine. The primary advantage ofthe new ring spinner is its ability to produce a finer-quality yarn thatwould be used for higher-quality and higher-margin products. The finer quality yarnwould be sold in a niche market that would command a 10% increase in the selling priceof yarn which was currently $1.0235 a pound. In addition, the new machine wouldprovide increased efficiency as well as greater reliability. The efficiency ofthe new machine would also reduce operating costs with lower power consumption andmaintenance expenses. Sales volume, however, would be 5% lower than the currentmarket and the cost of customer returns would be higher, which made the decision adifficult one when combined with the $8.25 million installation cost. The decision to invest in newtechnology was complicated because of the poor performance of Modern Textiles aswell as the difficult circumstances facing the Textile Industry. Modern Textileswas, however, competing in select markets that were likely to survive foreigncompetition at a lower margin over the long run. Modern Textiles was a yarn manufacturerestablished in 1980. The finished products were cotton and synthetic/cottonblend yarns that were sold to a variety of apparel and industrial goods manufacturers.It served four major customer segments: hosiery, knitted outerwear, wovens, and industrialand specialty products. The revenue break-up of Modern Textiles for varioussegments are: Hosiery 43% Knitted outerwear 35% Wovens 13% Industrial and Specialty 9% Exhibits 1 and 2 show ModernTextiles’ financial statements for 2012, 2013, 2014, and 2015. The steady decline in saleshad led the management to close four manufacturing facilities in 2014 in an effortto match the capacity to the shrinking textile market and reduce manufacturing costs. The textile market has beenchanging over time. While India had the advantage of major cotton producing andexporting country, competition from China, Vietnam and Indonesia has reduced thecompetitive advantage of Indian textile industry. Consumer preferences and fadsalso shaped the market. The emphasis in the industry had shifted from mass productionto flexible manufacturing as textile mills aimed to supply customised markets. Thischange enabled apparel producers to bring goods to retailers and consumers in ashort time frame. In general, consumer preferences had moved towards finer quality yarnwith minimum defects. Information technology also haddownside risk for yarn producers as the apparel manufacturer can easily identifythe yarn producer whose yarn was defective and this FIN303 Copyright © 2016 SIMUniversity Page 3 of 8 caused the returns frommanufacturers of apparel to increase. This is important because Modern Textiles needs to producehigh quality yarn with low amount of defects. Like many of its competitors,Modern Textiles had been struggling financially. The company had not responded quicklyto the deteriorating business environment and had suffered consecutive losses forthe past 3 years. Currently, the company had limited cash available and had troublemaintaining sufficient working capital. Since 2014, the company had succeeded in cuttingits selling, general and administrative (SG&A) expenses by $3.9 million. Theseefforts had allowed the company to continue operations but the difficultfinancial environment was expected to continue to present a challenge for Modern Textiles. New Machinery The new machinery will be inoperation for 4 years. It will cost $8.05 million to purchase the machinery and therewould be an installation cost of $200,000 for a total capitalised cost of $8.25million. The machinery will be depreciatedon a straight line basis over 4 years to zero book value. However, it can be soldfor $100,000 in the open market at the end of 4 years. Modern Textiles had already spent$15,000 on marketing research to gauge customer interest in it yarn as well as$5,000 on engineering tests concerning the suitability of ventilation, materials flow andinventory systems in its plant. The cost structure of a textileplant was primarily composed of materials cost and conversion cost which includesthe cost of labour, dyes, chemicals, power, maintenance, consumer returns fordefects and various other production and overhead costs. In 2015, the conversioncost was $0.43/lb. Most of the conversion costs will not be affected when new machine isinstalled. There will be no change in the work force but the current operators wouldneed to be trained on the new machine at a one-time cost of $50,000 during theinstallation year. Exhibit 3 shows the details ofdemand for yarn as well as the costs associated with the new machine. The target capital structure forModern Textiles is 50% debt and 50% equity. The risk free rate is 2.8%. The marketrisk premium is 6%. The beta of Modern Textiles is 1.2. The cost of debt for ModernTextiles is 5%. Tax rate is 20%. FIN303 Copyright © 2016 SIMUniversity Page 4 of 8 Exhibit 1Balance Sheet for the years ending 31 December. (Figures in $000) 2012 2013 2014 2015 Assets Cash and Cash equivalents 1, 144 5,508 2,192 1,973 Accounts Receivables, net 17,322 11,663 20,390 26,068 Inventory 34,778 33,155 31,313 33,278 Other Current Assets 2,774 1,922 713 2,378 Total Current Assets 56,018 52,248 54,608 63,697 Property and equipment Land 2,654 2,594 2,516 2,505 Buildings 32,729 31,859 30,308 30,427 Machinery and Equipment 230,759 220,615 197,889 190,410 Gross PPE 266,142 255,068 230,713 223,342 Less Accumulated Depreciation -147,891 -147,104 -146,302 -154,658 Net PPE 118,251 107,964 84,411 68,684 Other non-current assets 4,696 4,678 4,004 3,610 Total non-current assets 122,947 112,642 88,415 72,294 Total Assets 178,965 164,890 143,023 135,991 Liabilities Accounts Payable 12,236 7,693 9,667 10,835 Accruals 10,061 8,716 9,017 9,316 Current portion of long-term debt 1,009 1,730 0 0 Total current Liabilities 23,306 18,139 18,684 20,151 Long-term debt 66,991 66,991 58,000 58,000 Other Long-term Liabilities 16,566 14,081 11,776 10,297 Total Long-term Liabilities 83,557 81,072 69,776 68,297 Total Liabilities 106,863 99,211 88,460 88,448 Shareholder equity Common Stock, par $0.01 50 50 50 50 Capital Surplus 15,868 15,678 15,668 15,668 Retained earnings 56,184 49,951 38,845 31,825 Total Shareholder Equity 72,102 65,679 54,563 47,543 Total Liabilities and Shareholder Equity 178,965 164,890 143,023 135,991 Exhibit 2 IncomeStatements for the years ending December 31 (Figures in $000) 2012 2013 2014 2015 Pounds shipped (000s) 187,673 190,473 151,893 144,116 Average selling price/lb 1.3103 1.2064 1.2045 1.0235 conversion cost/lb 0.4447 0.4421 0.4465 0.4296 Average raw material cost/lb 0.7077 0.6429 0.6487 0.4509 Net sales 245,908 229,787 182,955 147,503 Raw Material cost 132,812 122,461 98,536 64,982 Cost of conversion 83,455 84,212 67,822 61,912 Gross profit 29,641 23,114 16,597 20,609 Depreciation and Amortisation 15,241 13,005 11,196 9,859 Operating profit -203 -4,109 -6,234 445 Interest Expense 6,777 6,773 5,130 3,440 Other income (expense) 1,143 -1,232 -409 Asset Impairments -4,758 -7,564 Earnings before tax -6980 -9739 -17,354 -10,968 tax at 20% -1,396 -1,948 -3,471 -2,194 Net profit -5,584 -7,791 -13,883 -8,774 Net profit before impairment cost -5,584 -7,791 -9,125 -1,210 SG and A expenses 14,603 14,218 11,635 10,305 Exhibit 3 Demandand costs associated with new machinery 2016 Sales volume (in pounds) 26,000,000 selling price per pound 1.126 Cost of cotton per pound 0.45 Conversion cost/lb 0.41 SG&A expenses 7% Inventory days 20 Cost of Machinery 8,250,000 Inventory days reflect the amountof yarn produced and valued as 20 days of sales. It is assumed that the number of daysin a year is 365. Question 1 Compute the following ratios in2015: 2012 2013 2014 2015 ROE (before impairment) -0.077 -0.119 -0.167 Gross profit margin 0.121 0.101 0.091 Net profit margin (before impairment) -0.023 -0.034 -0.050 Current ratio 2.404 2.880 2.923 Quick Ratio 0.911 1.053 1.247 Days sales outstanding 25.359 18.272 40.121 Inventory turnover 3.819 3.694 3.147 Fixed Asset turnover 2.000 2.040 2.069 Total asset turnover 1.374 1.394 1.279 Long term debt to (longterm debt + equity) 0.482 0.505 0.515 Equity Multiplier (TA/E) 2.482 2.511 2.621 (10 marks) Question 2 Analyse the changes in the returnon equity using other ratios. (15 marks) Question 3 Ravi of Modern Textiles is notsure what discount rate should be used for capital budgeting purposes. ModernTextiles is running short of cash for this investment and it is likely that Modern Textileswill have to borrow the amount of $8.25 million for undertaking this project. Thus hefeels that the appropriate discount rate should be the cost of debt. However, hiscolleagues are of the opinion that financing option is not relevant in capital budgetingdecision and hence should use the weighted average cost of capital. Analyse what rate should be usedfor discounting the cash flows. (10 marks) Question 4 Calculate the weighted averagecost of capital for the company. (15 marks) FIN303 Copyright © 2016 SIMUniversity Page 7 of 8 Examination – January Semester2016 Question 5 Modern Textiles had already spent$15,000 on marketing research to gauge customer interest in it yarn as well as$5,000 on engineering tests concerning the suitability of ventilation, materials flow andinventory systems in its plant. Discuss how this amount spent onmarketing research and engineering tests be treated in capital budgeting analysis. (5 marks) Question 6 There will be no change in thework force but the current operators would need to be trained on the new machine at aone-time cost of $50,000 during the installation year. Discuss how this expense shouldbe treated in capital budgeting analysis. (5 marks) Question 7 Calculate the net present valueand analyse the investment decision. Complete the following table and discusswhether the project should be accepted or not. Sales volume (in pounds) 26,000,000 selling price per pound 1.126 Cost of cotton per pound 0.45 Conversion cost/lb 0.41 SG&A expenses 7% Inventory days 20 Cost of Machin
Welcome to one of the most trusted essay writing services with track record among students. We specialize in connecting students in need of high-quality essay writing help with skilled writers who can deliver just that. Explore the ratings of our essay writers and choose the one that best aligns with your requirements. When you rely on our online essay writing service, rest assured that you will receive a top-notch, plagiarism-free A-level paper. Our experienced professionals write each paper from scratch, carefully following your instructions. Request a paper from us and experience 100% originality.
Check your essay before you submit. See exactly what your professor sees.
See your AI and plagiarism results before your instructor does.Get the exact same report your professor uses. Trusted by 50,000+ students worldwide.
From stress to success – hire a pro essay writer!
