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Expansion and Risk at Hansson Private Label, Inc

Analysis

10/25/2014

Sohail bilawal raza 1335175


Expansion and Risk at Hansson Private Label, Inc.: Evaluating Investment in the Goliath
Facility
Companys Business Operations, Strategy and Past Performance
HPL
HPL is a manufacturer of personal care products for retail partners. Its strategy has always been
to focus on efficiency, cost control and customer relation to guarantee solid revenue grows until
2007. Expansions have always been carefully analyzed and the Company never worked below
60% capacity utilization.
HPL has been able to grow its revenues to $ 681 million in 2007 accounting for 28% of national
consumption but the Company is working close to maximum capacity. On the other way, its
performance on units sold is growing only at 1% per year and, since capacity utilization
averages 90%, there is no room for further increase in revenues if not through expansion to a
new facility.
Opportunity
The opportunity has its risks. An initial investment of USD 45 million will be necessary and the
Client, who is already HPL biggest one, only commits to a 3 year term contract.
In addition, the necessary investment would double HPL debit and significantly increase its
financial leverage. Consequently, any financial distress form the client would seriously
jeopardize HPLs financial stability.
Project Forecasts
Cash Flow

Using the WACC of 9.38% associated to a Company with similar leverage, the NPV of the
project is estimated in $ 11.373 million. O the same way, the associated Internal Rate of Return
is 12.94%.

NPV Sensitivity to Price Variations
A sensitive analysis to changes in prices was performed to assess the projects sensibility to price
fluctuations.
At an initial selling price of $ 1.90 per unit, the projected cash flow would be the following:
Current 2009 2010 2011 2012 2013
Net Operating Profit After Tax $2.854 $4.161 $4.987 $6.064 $6.973
Plus: Depreciation $4.000 $4.000 $4.000 $4.000 $4.000
Less: Change in working capital ($12.848) ($1.469) ($1.438) ($1.525) ($1.547)
Total future cash flows ($45.000) ($5.994) $6.693 $7.549 $8.539 $9.427
2014 2015 2016 2017 2018
Net Operating Profit After Tax $8.150 $8.442 $8.737 $9.035 $9.336
Plus: Depreciation $4.000 $4.000 $4.000 $4.000 $4.000
Less: Change in working capital ($1.639) ($422) ($430) ($438) ($446)
Total future cash flows $10.511 $12.020 $12.307 $12.597 $12.889

It is worth notice that final WC in 2018 has been added to Future Value of OCF.
Based on the new OCF, NPV would increase to $ 40.120 (253% variation) and new IRR would
be 21.05% (63% variation).
At an initial selling price of $ 2.00 per unit, the projected cash flow has shown even higher
sensitivity with a $ 62.234 NPV (447% variation) and 26.69% IRR (106% variation).

The sensitivity analysis has shown that the project is highly sensitive to price changes. Since
price is exogenous to HPL, it represents higher risk to the project success.
Analysis
Using the full project cycle as a basis for analysis has resulted in positive NPV and IRR above
the applied discount rate. But the analysis does not factor a possible reduction of capacity
utilization should the Client not extend the contract or HPL find alternative ways to keep
production levels.
In addition, Payback period on all scenarios occur after 2011, year that the Contract will expire.
That is an additional risk since should HPL need to terminate the project, salvage value most
likely would not be sufficient to cover initial investment and incurred expenses.
Since better quality products have already increased its acceptance in the market, a possible
strategy would be to continue production after 2011 with a proprietary low-cost/good quality
product to be distributed on other retailers. Also, it would be possible to offer production
capability to high price brand owners to a lower production cost since the new plant would be
already partly amortized. I.e., the better strategy to deal with risks inherent to the contract is
diversification of brands.
To illustrate the issue on capacity utilization, a sensitivity analysis projecting maximum
capacity at 75% by 2012 has resulted in a $ 584 thousand NPV and 9.59% IRR. Based on that is
safe to state that keeping production levels above the 75% mark is key to the project success.

At $1.90 Current 2009 2010 2011 2012 2013
Net Operating Income Before Tax $10.512 $13.296 $15.298 $17.741 $19.929
Net Operating Income $6.307 $7.977 $9.179 $10.645 $11.957
Future Value of OCF ($45.000) ($3.970) $10.359 $11.585 $12.959 $14.244
Present Value of OCF ($45.000) ($3.630) $8.658 $8.853 $9.054 $9.098
At $1.90 2014 2015 2016 2017 2018
Net Operating Income Before Tax $22.586 $23.253 $23.928 $24.612 $25.304
Net Operating Income $13.551 $13.952 $14.357 $14.767 $15.182
Future Value of OCF $15.740 $17.485 $17.881 $18.283 $43.310
Present Value of OCF $9.192 $9.335 $8.728 $8.159 $17.671
At $2.00 2009 2010 2011 2012 2013
Net Operating Income Before Tax $14.939 $18.188 $20.672 $23.614 $26.319
Net Operating Income $8.964 $10.913 $12.403 $14.169 $15.791
Future Value of OCF ($45.000) ($2.413) $13.179 $14.690 $16.359 $17.949
Present Value of OCF ($45.000) ($2.206) $11.015 $11.226 $11.429 $11.465
At $2.00 2014 2015 2016 2017 2018
Net Operating Income Before Tax $29.511 $30.316 $31.133 $31.961 $32.800
Net Operating Income $17.706 $18.190 $18.680 $19.177 $19.680
Future Value of OCF $19.762 $21.689 $22.169 $22.656 $49.633
Present Value of OCF $11.541 $11.580 $10.821 $10.111 $20.251