HBR Hannson Final Case Analysis
What would the NPV be if the project went for only 3 years and was not renewed? NPV is -$37,254,000 with a -36.795% IRR.
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What would the NPV be if the project went for only 3 years and was not renewed? NPV is -$37,254,000 with a -36.795% IRR. This negative value indicates a loss and based on this alone we should not take the risk. What would the remaining cash flow minimums need to be to break even if contract stopped after 3 years? HPL would need an additional $14,800,500 in order to have a 0 NPV after just 3 years and break even, as well as a 9% IRR after 3 years. Considering we are already assuming a ~5% growth rate for the first three years and a market growth rate of less that 1% in the past four years, this additional $14,800,500 would be highly unlikely to occur. If contract continued for 10 years with the additional revenue of $14,800,500 what would be the 10 year NPV? NPV is $114,549,000 and IRR is 43%.
0 Total Revenue Less: COGS Gross Profit Less: SG&A EBITDA Less taxes (40%) Depreciation less taxes (*.4) Additional Revenue needed Working Capital Total Cash Flows PV NPV NPV IRR IRR
-‐45,000 -‐45,000 -‐45,000 -‐45,000
1 84,960 -‐69,930 15,030 -‐6,627 8,403 3,361 5,042 1,600 14,801 -‐12,817 8,625 7,890 -‐37,110
Additional Revenue Needed to Break Even after 3 years. 2 3 4 5 6 93,881 103,124 112,700 122,618 132,887 -‐75,957 -‐83,086 -‐90,106 -‐97,355 -‐104,842 17,924 20,038 22,595 25,263 28,045 -‐7,323 -‐8,044 -‐8,791 -‐9,564 -‐10,365 10,601 11,995 13,804 15,699 17,680 4,240 4,798 5,522 6,280 7,072 6,361 7,197 8,282 9,419 10,608 1,600 1,600 1,600 1,600 1,600 14,801 14,801 14,801 14,801 14,801 22,761 19,047 -‐18,063
23,597 18,063 0
24,683 17,284 17,284
25,820 16,539 33,824
27,009 15,826 49,650
7 135,545 -‐106,796 28,749 -‐10,573 18,177 7,271 10,906 1,600 14,801
8 138,256 -‐108,801 29,455 -‐10,784 18,671 7,468 11,203 1,600 14,801
9 141,021 -‐110,857 30,164 -‐11,000 19,164 7,666 11,498 1,600 14,801
27,306 14,637 64,287
27,603 13,535 77,822
27,899 12,514 90,336
10 143,841 -‐112,968 30,873 -‐11,220 19,654 7,862 11,792 1,600 14,801 30,817 59,010 24,213 114,549
$114,549 after 10 years 43% after 10 years 9% after 3 years
If contract continued for 10 years and there was additional growth up to 85% of capacity utilization, what is the NPV? NPV is $20,875,000 and IRR is 16% after 10 years.
How can we mitigate the 3-year risk of a negative NPV of -$37,254,000 and gain further revenue equal to $14,800,500 per year? We could mitigate the risk by selling unused capacity over and above what is already accounted for in the analysis or selling the facility if contract isn’t renewed after 3 years. However, even with this option you arrive at a negative NPV after three years. Selling Unused Capacity - During the first 3 years capacity utilization is equal to or above the 60% goal of the company. However, the company has far exceeded that goal by growing to 90% capacity in 4 of its current plants. If the facility can increase its capacity utilization by 20% in year 1, then by year 3 capacity will be at 90%. The new facility creates the opportunity to grow HPL’s other customer relationships beyond its largest retail customer. If that occurs the NPV will after 3 years increases to -$20,001,000. The NPV after 10 years increases to $59,629,000. However, you still have a negative IRR of -14%.
Total Capacity Capacity Utilization Unit Volume Selling Price Per Unit Revenue
Additional Capacity Utilization 1 2 3 4 5 6 7 8 9 10 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80% 85% 90% 95% 100% 95% 95% 95% 95% 95% 64000 68000 72000 76000 80000 76000 76000 76000 76000 76000 1.77 1.8054 1.841508 1.878338 1.915905 1.954223 1.993307 2.033174 2.073837 2.115314 113280 122767.2 132588.6 142753.7 153272.4 148520.9 151491.4 154521.2 157611.6 160763.9 0
Total Revenue Less: COGS Gross Profit Less: SG&A EBITDA Less taxes (40%) Depreciation less taxes (*.4) Additional Revenue needed Working Capital Total Cash Flows PV NPV NPV IRR IRR
-‐45,000 -‐45,000 -‐45,000 -‐45,000
1 113,280 -‐84,970 28,310 -‐8,836 19,474 7,790 11,684 1,600 0 -‐12,817 467 428 -‐44,572
NPV with Additional Capacity Utilization 2 3 4 5 122,767 132,589 142,754 153,272 -‐91,148 -‐98,429 -‐105,601 -‐113,005 31,620 34,160 37,152 40,267 -‐9,576 -‐10,342 -‐11,135 -‐11,955 22,044 23,818 26,017 28,312 8,818 9,527 10,407 11,325 13,226 14,291 15,610 16,987 1,600 1,600 1,600 1,600 0 0 0 0
$59,629 after 10 years 27% after 10 years -‐14% after 3 years
14,826 12,407 -‐32,166
15,891 12,164 -‐20,001
17,210 12,052 -‐7,950
18,587 11,906 3,956
6 148,521 -‐112,745 35,776 -‐11,585 24,191 9,676 14,515 1,600 0
7 151,491 -‐114,779 36,713 -‐11,816 24,897 9,959 14,938 1,600 0
8 154,521 -‐116,863 37,658 -‐12,053 25,605 10,242 15,363 1,600 0
9 157,612 -‐119,000 38,611 -‐12,294 26,317 10,527 15,790 1,600 0
16,115 9,443 13,399
16,538 8,865 22,264
16,963 8,318 30,582
17,390 7,801 38,382
10 160,764 -‐121,192 39,571 -‐12,540 27,032 10,813 16,219 1,600 0 33,961 51,780 21,247 59,629
However, it may be difficult to get other retailers on board to use the additional capacity. This is because all unit growth comes from private label penetration gains that, although steady, are too modest to support significant expansions by multiple producers. What will happen if there is a decrease in sales? Any slight decrease in selling price per unit would be a huge risk to the investment at its current NPV. By looking at Exhibit 4, you can see that there was an increase in sales from all channels for HPL from 2003 to 2007. However, the percent increase actually decreased by an average of 0.08% over those 5 years. This type of decrease could have a strong adverse impact on HPL’s selling of its new product after the contract ends in 3 years, if it is not renewed. Additionally, to continue the upward trend of sales, we must account for development of new products in order to facilitate growth, and the cost of this development and the sales structure to support the new products could far exceed our initial investment. And since this market isn’t growing substantially, we would have to take market share from our competitors. In most cases this is even more difficult than developing new products. Increase in Raw Material cost per unit – An increase in raw material cost by a growth rate of just .1% per year, will decrease the NPV by $1,000,000 by year 10.
0 Total Revenue Less: COGS Gross Profit Less: SG&A EBITDA Less taxes (40%) Depreciation less taxes (*.4) Additional Revenue needed Working Capital Total Cash Flows PV NPV NPV IRR
-‐45,000 -‐45,000 -‐45,000 -‐45,000
1 84,960 -‐69,930 15,030 -‐6,627 8,403 3,361 5,042 1,600 0 -‐12,817 -‐6,175 -‐5,649 -‐50,649
$19,058 after 10 years 15% after 10 years
2 93,881 -‐76,055 17,826 -‐7,323 10,503 4,201 6,302 1,600 0 7,902 6,612 -‐44,036
NPV w/ Increase in Raw Material Price 3 4 5 6 103,124 112,700 122,618 132,887 -‐83,299 -‐90,452 -‐97,852 -‐105,509 19,825 22,249 24,766 27,378 -‐8,044 -‐8,791 -‐9,564 -‐10,365 11,782 13,458 15,202 17,012 4,713 5,383 6,081 6,805 7,069 8,075 9,121 10,207 1,600 1,600 1,600 1,600 0 0 0 0 8,669 6,636 -‐37,400
9,675 6,775 -‐30,626
10,721 6,867 -‐23,758
11,807 6,919 -‐16,839
7 135,545 -‐107,606 27,939 -‐10,573 17,366 6,947 10,420 1,600 0
8 138,256 -‐109,756 28,500 -‐10,784 17,716 7,086 10,629 1,600 0
9 141,021 -‐111,961 29,059 -‐11,000 18,060 7,224 10,836 1,600 0
12,020 6,443 -‐10,396
12,229 5,997 -‐4,400
12,436 5,578 1,178
Decrease in Capacity Utilization – If the retailer does not renew the contract after 3 years, but HPL is able to get other retailers on board at a minimal capacity of at least 60% for the subsequent 7 years, the 10 year NPV will decrease to -$103,627,000.
Total Capacity Capacity Utilization Unit Volume Selling Price Per Unit Revenue
1 80,000 60% 48000 1.77 84960
Decrease In Capacity Use 2 3 4 5 6 7 8 9 10 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 65% 70% 60% 60% 60% 60% 60% 60% 60% 52000 56000 48000 48000 48000 48000 48000 48000 48000 1.8054 1.841508 1.878338 1.915905 1.954223 1.993307 2.033174 2.073837 2.115314 93880.8 103124.4 90160.23 91963.44 93802.71 95678.76 97592.33 99544.18 101535.1
0 Total Revenue Less: COGS Gross Profit Less: SG&A EBITDA Less taxes (40%) Depreciation less taxes (*.4) Additional Revenue needed Working Capital Total Cash Flows PV NPV NPV
-‐45,000 -‐45,000 -‐45,000 -‐45,000
1 84,960 -‐84,970 -‐10 -‐6,627 -‐6,637 -‐2,655 -‐3,982 1,600 0 -‐12,817 -‐15,199 -‐13,904 -‐58,904
NPV w/ Decrease in Capacity Use 2 3 4 93,881 103,124 90,160 -‐91,148 -‐98,429 -‐105,601 2,733 4,696 -‐15,441 -‐7,323 -‐8,044 -‐7,032 -‐4,590 -‐3,348 -‐22,474 -‐1,836 -‐1,339 -‐8,989 -‐2,754 -‐2,009 -‐13,484 1,600 1,600 1,600 0 0 0 -‐1,154 -‐965 -‐59,869
-‐409 -‐313 -‐60,182
-‐11,884 -‐8,322 -‐68,504
5 91,963 -‐113,005 -‐21,042 -‐7,173 -‐28,215 -‐11,286 -‐16,929 1,600 0
6 93,803 -‐112,745 -‐18,943 -‐7,317 -‐26,259 -‐10,504 -‐15,756 1,600 0
7 95,679 -‐114,779 -‐19,100 -‐7,463 -‐26,563 -‐10,625 -‐15,938 1,600 0
8 97,592 -‐116,863 -‐19,271 -‐7,612 -‐26,883 -‐10,753 -‐16,130 1,600 0
9 99,544 -‐119,000 -‐19,456 -‐7,764 -‐27,221 -‐10,888 -‐16,332 1,600 0
-‐15,329 -‐9,819 -‐78,323
-‐14,156 -‐8,295 -‐86,618
-‐14,338 -‐7,685 -‐94,303
-‐14,530 -‐7,125 -‐101,428
-‐14,732 -‐6,608 -‐108,036
10 101,535 -‐121,192 -‐19,657 -‐7,920 -‐27,577 -‐11,031 -‐16,546 1,600 0 25,691 10,745 4,409 -‐103,627
($103,627) after 10 years
How much risk should HPL tolerate? There is too much risk to tolerate. Even after increasing or selling unused capacity, HPL will be unable to produce enough revenue to break even after 3 years and garnish an IRR that is above the WACC. There is too much vulnerability to decreases in capacity usage, sales, and increase in raw material costs to be able to mitigate them. We are already assuming an increase in efficiency, gaining market share over our competitors, and an increasing market premium that hasn’t been proven. Sales strategies to support this aggressive plan have not been developed yet, and the costs associated with them are unknown.
Overall Conclusion Based on the lengthy period to achieve payback from the initial investment, the cost to get out of the investment after three years, along with the inability to mitigate the risk without selling the facility and adjusting for sales target increases in this analysis, we should not make this additional investment.