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Hansson Private Label

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Hansson Private LabelHansson Private LabelHansson Private
1. How would you describe HPL and its position within the private label personal care industry?
HPL is a mid-sized private label manufacturer of personal care goods. In 1992, the company acquired production assets from Simons Health and Beauty Products, and through increased efficiency had enjoyed growth within the sector. The company’s production is estimated to account for about 28% of the $4 billion sold in their product category, generating revenue of $681 million in 2007.
The company was recently presented an opportunity by its largest retail customer to significantly increase its share in their private label manufacturing. The prospect of growth was risky, since it required an initial investment larger than any HPL had previously encountered. The 3-year contract offered was also relatively short. The company would be running the risk of discontinued business after expiration and subsequent heavy losses. However, the upside was obvious. If the company succeeds by locking in long-term business with a powerful retailer, it will surely pay off for many years to come. A special quality of the private label business is that manufacturers generally produce at levels demanded by the retailers they produce for. Even though private labels have been steadily gaining market penetration due to quality improvements, growth in the overall market were modest, leaving manufacturers little opportunities for big investments.
Therefore, HPL had a major decision to make. Either take a big risk at a chance for big returns, or stay conservative and remain a middle of the pack player in the industry.
2. Using assumptions made by Executive VP of Manufacturing, Robert Gates, estimate the project’s FCFs. Are Gates’ projections realistic? If not what changes might you incorporate?
The FCF is calculated in three steps. For a detailed calculation you might want to check Table 1 below. First, we calculate the Income statement from the numbers provided in Exhibit 5.
EBIT = Revenue – COGS – SGA
OCF = EBIT – Taxes + Depreciation
Second, we calculate the changes in working capital using the DSO, DSI and DPO ratios provided in the request form.
Capital Expenditure = Change in Net Working Capital
Net Working Capital = Current Asset – Current Liabilities
= A/R + Inventory – A/P
A/R = DSO * (Revenue / Number of days in Period)
Inventory = DSI * (COGS / Number of days in Period)
A/P = DPO * (COGS/ Number of Days in Period)
Afterwards we have all calculation available to estimate the Free Cash Flow (FCF), calculated as following
FCF = OCF – Capital expenditure
Referring to Exhibit 5, Executive VP of Manufacturing Robert Gates based his capital request form on a ten-year deal to estimate the project’s FCFs. However, from the information provided in the case we know that “the customer would commit to only a three-year contract”. Robert Gates financial assumptions expect capacity utilization to be increasing during the course of the project, but don’t take into account the operational risks that might occur from a changing “relationship with the customer” or a disappearing “demand (…) at the end of the initial three-year contract”.
Consequently, this would decrease revenue and reduce the FCF. Also, the risk measurement for a ten-year estimation shouldn’t be neglected. First, “making this (…) investment and incurring the associated debt (…) increases HPL’s (…) risk of financial distress should sales fall, costs rise, or both”.
Therefore, HPL is exposed to a high risk to their financial returns from the investment unless they find other credit-worthy retail partners. Moreover, Robert Gates’ estimation of the price increase (2.0%) differs from the information provided in the case (1.7%). This overestimates revenue and thereby FCF. To make better projections for the firms’ FCF, Robert Gates would also have to consider the opportunity cost of alternative investments, the risk exposure throughout the project and operational risks after three years.
3. Estimate the project’s NPV. Would you recommend that Tucker Hansson proceed with the investment?
The total initial The total initial The total initial The total initial The total initial The total initial investment investmentinvestmentinvestmentinvestment of the project is $57817. Amongof the project is $57817. Amongof the project is $57817. Amongof the project is $57817. Among of the project is $57817. Amongof the project is $57817. Among of the project is $57817. Among of the project is $57817. Among of the project is $57817. Amongof the project is $57817. Amongof the project is $57817. Amongof the project is $57817. Amongof the project is $57817. Amongof the project is $57817. Among of the project is $57817. Among of the project is $57817. Among of the project is $57817. Amongof the project is $57817. Among the the initial investment initial investment initial investment initial investment initial investmentinitial investment initial investment, $45000 belong belong to the purchase the purchasethe purchase of of equipment equipment equipment and and $12817 go $12817 go $12817 go $12817 go$12817 go$12817 go in to workworkwork ing ing capital capital capital capital capital that will be returned will be returned will be returned will be returned will be returned will be returned at the end of the end of the end of the end of the end of the end of project project project. BaseBase d on the given the given the given the given the given data we data we data we data we data we don’t don’t know know know know the exact exact exact period period of the whole project. of the whole project. of the whole project. of the whole project. of the whole project. of the whole project. of the whole project. of the whole project. of the whole project. of the whole project. However, However, However, However, However, However, we we we knowknow know that the that the that the that the purpose of purpose ofpurpose ofpurpose of purpose ofpurpose of the investment investment investmentinvestment in 2008 i in 2008 iin 2008 i in 2008 i in 2008 iin 2008 involves nvolves nvolvesnvolves a three -year contractyear contract year contractyear contract year contract year contract with a creditwith a credit with a creditwith a creditwith a creditwith a credit with a creditwith a credit -worthy retail worthy retail worthy retail worthy retail worthy retail worthy retail worthy retail worthy retail partner partner . At At the same time we the same time we the same time we the same time we the same time we the same time we the same time we the same time we the same time we the same time we have information about a ten have information about a tenhave information about a ten have information about a ten have information about a tenhave information about a ten have information about a ten have information about a ten have information about a ten have information about a ten have information about a tenhave information about a ten have information about a ten -year year year forecast forecast forecast forecast forecast of the of the of the of the of the of the project project project (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us (from 2009 to 2019), which lets us assume that assume that assume that assume that assume that assume that the the investment investment investment investment investment investment is considered considered considered considered considered considered for afor a for a longer longer longer periodperiod period than that of than that ofthan that of than that ofthan that of three three years;years; years; years; maybe maybe maybe ten or even even more. more. more. more.
The NPV is given by NPV is given byNPV is given byNPV is given byNPV is given byNPV is given byNPV is given byNPV is given by NPV is given by NPV is given byNPV is given by where Rt = net cash flow in tRt = net cash flow in t Rt = net cash flow in tRt = net cash flow in tRt = net cash flow in t Rt = net cash flow in tRt = net cash flow in t Rt = net cash flow in tRt = net cash flow in t Rt = net cash flow in tRt = net cash flow in t Rt = net cash flow in tRt = net cash flow in tRt = net cash flow in t Rt = net cash flow in tRt = net cash flow in t t = t = t = period of the project period of the project period of the projectperiod of the project period of the projectperiod of the project period of the project period of the projectperiod of the project period of the project = 1~10 i = discount rate discount ratediscount rate discount ratediscount rate discount

The The cal culation culation of the projectof the projectof the projectof the project of the projectof the project ’s NPV NPV NPV re quires quiresquires a dis count rate. count rate. count rate. count rate. count rate. count rate. As we werenAs we werenAs we werenAs we werenAs we werenAs we werenAs we werenAs we werenAs we weren ’t asked t asked t asked t asked t asked t asked to to to use CFO SheilaCFO SheilaCFO SheilaCFO SheilaCFO Sheila CFO Sheila Dowling’s projected schedule to to calculate the calculate the calculate the WACCWACCWACCWACC as the as the as the underlying underlying underlying underlying discount rate, referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 referring to Exhibit 7 we simplicity we simplicity we simplicity we simplicity we simplicity we simplicity we simplicity we simplicity we simplicity we simplicity assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount assumed a discount rate of rate of rate of rate of 7.75%7.75%7.75% 7.75%. Taking aking aking aking the above mentioned above mentioned above mentioned above mentioned above mentioned above mentioned assumptions into consideratiassumptions into consideratiassumptions into consideratiassumptions into consideratiassumptions into considerati assumptions into considerati assumptions into considerati assumptions into consideratiassumptions into considerati assumptions into consideratiassumptions into considerati assumptions into consideratiassumptions into considerati assumptions into considerati on, on, we we we calculate d fo llowing llowing llowing llowing NPV NPV’s for for for Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc. Hansson Private Label, Inc.
Initial Initial InvestmentInvestment Investment InvestmentInvestment : $57: $57: $57 : $57.817, 817, 3 years, discount rate 73 years, discount rate 73 years, discount rate 73 years, discount rate 7 3 years, discount rate 73 years, discount rate 73 years, discount rate 7 3 years, discount rate 73 years, discount rate 7 3 years, discount rate 73 years, discount rate 73 years, discount rate 7 3 years, discount rate 7, 75, 75, 75 % % %
NPV NPV (Risk)(Risk)(Risk) (Risk)(Risk) = -36 .647, 647,647, 97 USD USD
Initial Initial InvestmentInvestment Investment InvestmentInvestment : $57: $57: $57 : $57.817, 817, 10 10 years, discount rate 7years, discount rate 7 years, discount rate 7years, discount rate 7years, discount rate 7 years, discount rate 7years, discount rate 7 years, discount rate 7years, discount rate 7 years, discount rate 7, 75, 75, 75 % % %
NPV NPV (Chance)(Chance)(Chance) (Chance) (Chance) = 11 = 11= 11.454, 88 USDUSD
Usingsing different differentdifferent different assumptions to calculate the assumptions to calculate theassumptions to calculate the assumptions to calculate theassumptions to calculate the assumptions to calculate theassumptions to calculate the assumptions to calculate theassumptions to calculate the assumptions to calculate the assumptions to calculate the discount rate ( discount rate (discount rate ( discount rate (discount rate ( discount rate ( discount rate (discount rate (see Table see Table see Table see Table see Table see Table see Table 2, i. e. e. e. 10 -Year Year Year TreasuryTreasury Treasury + Market Risk Premium Market Risk PremiumMarket Risk Premium Market Risk PremiumMarket Risk PremiumMarket Risk Premium Market Risk PremiumMarket Risk PremiumMarket Risk PremiumMarket Risk Premium Market Risk Premium Market Risk Premium = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC = 8.75 or WACC scheduleschedule schedule) willwill will change the change the change the change the NPV NPV by nearly by nearly by nearly by nearly by nearly -50 %. Estimating the NPV unEstimating the NPV unEstimating the NPV unEstimating the NPV un Estimating the NPV un Estimating the NPV unEstimating the NPV un Estimating the NPV unEstimating the NPV un Estimating the NPV unEstimating the NPV unEstimating the NPV un der different assumptions der different assumptionsder different assumptions der different assumptionsder different assumptionsder different assumptions der different assumptions der different assumptionsder different assumptions der different assumptionsder different assumptionsder different assumptions der different assumptions der different assumptions should be taken should be taken should be taken should be taken should be taken should be taken should be taken should be taken should be taken should be taken into con into con siderationsideration sideration sideration when calculate a discount rate for the project mightfor the project mightfor the project might for the project might for the project mightfor the project might for the project might for the project might for the project might give usgive us give us give us more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. more realistic numbers. Nevertheless, a Nevertheless, a Nevertheless, a Nevertheless, aNevertheless, aNevertheless, aNevertheless, aNevertheless, after fter fter calculating the calculating the calculating the calculating the calculating the NPV results NPV resultsNPV resultsNPV results NPV resultsNPV resultsNPV results we canwe canwe canwe can say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend say, that we recommend HPLHPLHPL to proceed with to proceed withto proceed with to proceed withto proceed with to proceed withto proceed withto proceed with the the investment in case of investment in case of investment in case of investment in case of investment in case of investment in case of investment in case of investment in case of investment in case of investment in case of investment in case of investment in case of a ten a ten -year period. year period. year period. year period. year period. year period.
Table 2:

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