Expansion and Risk at Hansson Private Label, Inc.
Evaluating Investment in the Goliath Facility HBS#4021
Vent Consulting takes pleasure in presenting our Hanson Private Label’s (HPL) capital expansion executive summary. We carefully reviewed all applicable case materials and believe we have quantified your primary risks, benefits, and most attractive course of action.
1) HPL has performed exceptionally well since inception in 1992. Financial statements show that operating revenues have increased from $503.4M in 2003 to $680.7M in 2007. During this time, gross operating profit increased by $24.3M. This illustrates that the company is not sacrificing profits for top level growth. Capital replenishment matches or …show more content…
Additionally, the calculated profitability index of 1.11 suggests the project should be pursued. Note that the discounted payback period is just under 7 years, 4 years beyond the contractual commitment under consideration with HPL’s largest retail customer.
3) Sensitivity analysis reveals interesting factors, however. Note in the additional tabs:
• Ramping up capacity utilization to 85% in 3 years instead of the projected 5 years yields a full 2% IRR increase.
• If aggressive marketing can capture secondary demand from competitors and increase capacity utilization from 85% to 95% in years 4 through 10, IRR is increased to 14.8%.
• The project is very sensitive to unit selling price. If expected annual growth in sales price rises from 2% to just 3.5%, IRR rises a full 6.7% to 17.8%.
• The project is also very sensitive to commodity costs. A small .5% increase in expected inflation from 1.0% to 1.5% annual raw material costs reduce baseline IRR calculations to 9.5%, making the project unattractive compared to the 9.38% discount rate.
• Improved capital planning yields expected improved project returns. The last tab illustrates a potential improvement of 2.5% IRR.
Given this information, Vent Consulting has identified 3 courses of action (COA): 1) Accept the capital expansion proposal as written by Mr. Gates 2) Accept the retailer ‘s 3–year contract, but reduce capital risk by
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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.
Southwest traditionally uses a 5% premium over the weighted average cost of capital as a discount rate for long-term projects. This makes certain that the project will only have a positive net present value and be worth the investment if it gives investors a premium for the additional risk they must take on. The expected return on the project of 14.5% gives a 5.9% premium over the calculated
Lastly, the company suggest to expand their current inventory through increasing production and capacity. With the increase in production rate the company can gain more consumers as a whole through supply and demand. Doing this would give the company an opportunity for more exposure and perhaps better brand recognition.
HCA, after following a conservative financial policy since its establishment, has entered the new decade preparing to make some changes in order to realign their financial strategy and capital structure. Since establishment, HCA has often been used as a measure for the entire proprietary hospital industry. Is it now time for the market to realign their expectations for the industry as a whole? HCA has target goals which need to be met in order to accomplish milestones in the future. The problem arises as to which area holds priority to the company. HCA must decide how the key components of their financial strategy and policy should my approached in order
Constantly growing firm with increasing revenue (15.5% in 2005), net profit, total assets and high returns on equity (5.1% in 2005)
Furthermore, a sensitivity analysis of factors such as the cost of raw materials, selling price per unit and capacity utilization demonstrates that a small change in any one of these variables could have a major impact on the project’s bottom line. In Appendix B, I examine a scenario in which the selling price per unit decreases by 1% and the cost of raw materials per unit increases by 1% at the outset of the project. In this scenario, the resulting NPV changes from a positive $5.4 million to a loss of $666,000, and the IRR falls below the discount rate to 9.15%. This, to me, reveals that the potential upside of this project is not large enough to account for discrepancies due to imprecise projections, flawed assumptions, or unforeseen risks.
The industry within which Hansson Private Label exists is a very competitive and volatile one. It is dominated by two types of firms, namely, Branded and Private Labels. Tucker Hansson operates as a private label firm. Private Label firms are an emerging market which is competitive based on its ability to have a lower price than its rivals. This market has experienced growth primarily because of this affordability. However this growth would be regarded as organic.
Financial Analysis The sensitivity analysis on IRR provided by the case in Exhibit 9 is demonstrated in Table 3 in Appendix. With reference to the calculated WACC, 11.22%, most of the circumstances considered in the sensitivity analysis suggest the acceptance of the 7E7 project. However, if the air travel demand worsened and sold only 1500 in the first 20 years, the project will be abandoned even if there is a 5% premium in price. If the unit volume sold is equal to
The Carded Graphics president and owner, Murry Pitts understands that purchasing a new sheeter is the best option for the company. The new sheeter will help the company develop a better, more agile product that can compare with competitors. The analysis will illustrate the returns on the project will greatly exceed the cost; this will add great value to the company. To determine if the project is worth taking on, some of the criteria to look at are the NPV, IRR, and payback period. If the project produces a positive NPV, an IRR greater than the required rate of return, and a short payback period, the company should obtain the new sheeter. After conducting the analysis, Pitts should proceed with investing in a new sheeter.
The present value of the net incremental cash flows, totaling $5,740K, is added to the present value of the Capital Cost Allowance (CCA) tax shield, provided by the Plant and Equipment of $599K, to arrive at the project’s NPV of $6,339K. (Please refer to Exhibit 4 and 5 for assumptions and detailed NPV calculations.) This high positive NPV means that the project will add a significant amount of value to FMI. In addition, using the incremental cash flows (excluding CCA) generated by the NPV calculation, we calculated the project’s IRR to be 28%. This means that the project will generate a higher rate of return than the company’s cost of capital of 10.05%. This is also a positive indication that the company should undertake the project.
Conversely, looking at the income statement for PMWL, operating income shows healthy gains of $45,862, which means the operating expenses are significantly lower in comparison to AWBL’s. However, PMWL’s cost of goods sold appear abnormally high, which makes an investor question whether this company is at it’s maturity phase in the product life cycle, and how much additional capital is necessary to bring this figure down to a number that leverages economies of scale and allows for profit maximization.