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The Company and its Investment

Hansson Private Label, Inc. (HPL) is a manufacturing company, owned by


Tucker Hansson, of personal care products such as shampoo, soap, mouthwash
and the like. They sell these products under the brand label of its retail
customers, which can be a retail partner and mass merchants having a
supermarket or drugstore. HPL have been surviving in the personal care
category by doing things like persuading large chains to carry their products by
providing adequate and highly visible shelf space. In this case study, HPL is
considering a three-year contract from its largest retail customer that could give a
significant rapid growth and value for the company. Since the company is already
operating almost at its full capacity, the three-year contract would require them to
expand their production facilities to meet the demand of the customer. However,
this opportunity entails also with it a significant risk, including Hanssons personal
risk, which may also lead the company and Hansson into a recession. Pursuing
this investment would also close off all the investment opportunities for the
foreseeable future.
Unlike HPLs usual investment it has more macro focus when it comes to
risk and payback because of additional risks. The interest expense and restrictive
covenants would be more expensive in terms of the cost of debt. It would also be
rare to have an equity financing that is favorable.

Factors to be considered in Decision-Making:


GOAL
HPLs goal is to be a leading provider of high quality private label personal care
products to Americas leading retailers. This is a very important factor to be
considered because the decisions to be made by the company should be in
parallel or align with the companys objective. In this case, having additional
capacity will give HPL a better customer-client relationship with its largest
customer. As a result, expansion would directly help the company to achieve
their main objective. However, the said investment would initially be done in only
three years according to the contract. Hansson considered this fact and thought
that the customers demand might disappear right after the commitment.
PRODUCT-CUSTOMERS
Products such as soap, shampoo, mouthwash, shaving cream, sunscreen and
the like was sold to HPLs retail partners as their private label brand product,
which included supermarkets, drug stores and mass merchants which serves as
the distributors of their products. These distributors are the ones who sell their
product to the patronizing customers. Also. in this kind of industry, manufacturers
rely heavily on a relatively small number of retailers that has a ubiquitous
presence since consumers purchased personal care products mainly through
retailers. As for HPL, their share in totals sales of personal care products through
retail stores is about 28%.

LIMITATIONS
The company is already operating at more than 90% of its capacity. To
accommodate the increase in the level of production, It would require an
additional facility.
The financial structure of the company will have a significant change in its
financial structure together with its debt management. The company, in its
existing management, maintained debt at a modest level in case of financial
distress involving lost of big customer. But now with the expansion, the company
will have to incur a high level of debt to finance the project. Another thing to be
pointed out, is that the sales that would support the capacity growth coming for
the new investment might come from what was already HPLs largest customer.
COMPETITION
As mentioned in the case, most of the manufacturers unit sales came
from its private label products distributed. In many years, the unit growth was
growing steadily. Given this, this will be too modest to support significant
expansions by different producers. As a result, the competitors of HPL may be
deterred from also expanding their production capacity in HPLs personal care
subsegments. More importantly, this announcement by HPL will give more
pressure to its competitors since it will be supported by a contract with a powerful
customer.

COLLABORATORS
The collaborators in the case are Robert Gates-HPLs Executive VP of
Manufacturing that led the team that developed the proposal (the investment),
Shiela Dowling, CFO, who did the cost of capital analysis and the scoring to
compare projects, and his staff and the managers who helped Hansson review
the analysis prepared by Dowling.
CAPITAL BUDGETING TECHNIQUE
The capital budgeting technique like NPV, PI, Payback Discounted
Payback and IRR, was computed using the discounted cash flows in order to
account the time value of money. The net present value (NPV) was calculated by
getting the excess of the present value of cash inflows over the present value of
the net investment (-45,000 + 56,538.81). Since the NPV is positive based on the
calculation to obtain the net present value, it means that there will be an addition
to the shareholders wealth due to the execution of the project. As for the
profitability index, it was calculated by dividing the present value of future cash
flows by the initial outlay (56,538.81/45,000). Since profitability index (PI) is
greater than 1, it means that the net present value will be positive so the
decision, if the PI is used as basis, would be to accept the project. Skipping to
internal rate of return (IRR), it is the rate that will yield a zero net present value.
The criteria whether to accept a project by using the IRR as basis is when it is
greater than the required rate of return, in this case the WACC, which is 9.38%.

C. Alternative courses of action


If Hansson could not decide whether to accept or reject the expansion or
decided to reject it, the group proposes three independent alternative courses of
action; Invest in treasury bonds, harvest mode (sell the company), or continue to
have incremental addition of new product types while waiting for other investment
opportunities.
The first alternative which is to invest in treasury bonds also sticking with
the current capacity. This alternative helps to avoid risks in expanding since they
are uncertain of how their customer would behave at the end of the three-year
contract. Only to cover the growing demand of their long-time customer would be
risky since factors that affects the performance of that customer would affect their
demand and it would really require a solid backup plan in order for them to utilize
well this additional capacity provided by the significant expansion in case this risk
materialize. In this alternative, the advantages are the consistency of Hansson by
being conservative in his investments, avoids the risks of losing his personal
money if the three-year contract went wrong, and having safer earnings than
expanding. The disadvantage of this alternative is the opportunity loss of the sure
earnings for the first three years and as stated in the case, there are numerous
private label and branded businesses who took the same risk that experienced a
big payout. Also, earnings in expanding are larger than just investing in treasury
bonds.

The second alternative is the harvest mode. Since Hansson was a serial
entrepreneur who spent 9 years buying businesses and selling them for profit
after he improved its efficiency and grew their sales. Now that he improved HPL,
he could now sell it for profit to escape the large risk of concentrating his
personal wealth to this business. In this alternative assuming that he cant sell it
within the allotted decision time of the contract, Hansson can choose to accept
the three-year contract without having any doubts because he will later sell it for
a profit before the expansion effects in the operations of the business, positive or
negative, takes place. This becomes an advantage to Hansson if the expansion
didnt go out well because he had sold the company before its value decline and
a disadvantage to HPL employees that some of them might lose their job
because of losses that cant be handled. On the other hand, its a disadvantage
to Hansson if the expansion improved the company so much that it creates an
opportunity loss to Hansson and an advantage to HPL employees. Another
advantage to him would be that he can buy another business he can improve
and or diversify his investments to avoid the same dilemma he is currently
encountering and to comply with his risk-averseness. The disadvantage here is
loyalty or trust issues in future business acquisition that Hansson might do the
same thing as HPL whenever there are big decisions to make.
The last alternative is to continue having incremental addition of product
types. The company has been doing this for the previous years by taking small
risks from introducing a new product to their shelf. With this they could take
advantage of the consumer acceptance of their product given that the market for

their products is growing. Another advantage of this is the growth of private label
and personal care products as shown in Exhibit 2 and 3 of the case but the
disadvantage is the growth is slow and as stated in the case it seemed meager
and unambitious. Moreover, while doing this alternative, they buy themselves a
little more time to wait for another opportunity that has lower risk than the current
opportunity at hand.
D. Recommendation
Our group recommends that Hansson Private Label, Inc. should take this
opportunity to expand since this is a good investment opportunity for their
business in a number of ways and also has repercussions if forgone. First on the
list is that if the company turns down this opportunity it might influence the future
transactions this long-time and trusted customer with them as the supplier of
private label products. We should remember that this customer is a business too
and if their management decides that they could expand by entering a contract
with a supplier, which in this case is HPL, Inc., and if HPL declines then they
could just look for another supplier to do this for them and this possible outcome
is really unfavourable for HPL since it would benefit their competitors. Another
reason for our recommendation is that with 2007 data available regarding dollar
share of HPL in their target markets, it shows that HPL holds 28% of the total for
that year for private label wholesales and also considering that 99.9% of U.S.
Consumers purchased at least 1 private label product for 2007, which means
market acceptance and for a business, you should take advantage of this and
establish market dominance. By expanding, you could increase your market

share up to a rough estimate of 30.40% - 31.46% (computed by adding the


incremental revenues to the current revenues that represent 28% of the total
then dividing it by the total wholesale dollar sales) and this is a good thing for you
since the more dominant you are in the market, the better since it you could
make it harder for new competitors to penetrate.
Our recommendation is also backed up in the quantitative side such as
project NPV, IRR, MIRR, profitability index, payback period, and discounted
payback period. As per exhibit#3, we can see that project NPV is positive
$11,538,810.96 which means that this project should be accepted. It also has
MIRR of 13% is greater than WACC of 9.38% so under cost-benefit analysis
benefit is heavier than costs and as for profitability index, this project gave us
1.26 P.I. which shows that for every dollar spent on this project it will give us a
return of 1.26 or .26 additional or return on investment. However, the payback
period of 6.68 years may be good but we cannot say as of now since the case
didnt provide data about the benchmark or standard payback period for their
projects and maybe because this is their first time to commit to a big investment
that will benefit them long-term. Since they would be able to generate more
products, they could try exporting as so that the demand for their product will
never be dependent to the market of United States only as this would reduce the
risks inherent in expanding. They should also try to look for partners and more
customers willing to give them a conspicuous shelf for their products as it may
maximize or help them be able to generate more sales than forecasted.

It is shown in exhibit#5 that a 10% change in selling price would have the
biggest effect or change in NPV as compared to 10% change in capacity and
direct costs. With this, our group recommends that HPL should try to gain market
dominance so that they could somehow dictate the price for private label
products. They should hire a reputable company for their market research in
order to optimize the selling price without jeopardizing the demand for their
products. Differentiating their products from others could also have an impact in
the market that their product is worth more than how much it is priced.