Hansson Private
Label, Inc (HPL), held 28% market share in the private label segment of the
personal care industry. The company had contracts with major national and
regional retailers that helped to raise its sales profile in the industry. The
personal care market was stable  but had
low volume increases of less than 1%. Most of the revenue growth in the
industry occurred through increases in price. HPL ‘s competitive strategy was
based on producing high quality products to cultivate customer loyalty and overcome
competition.

Free Cash Flow

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

Income
Statement

 2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Revenue

8%

$84,960

$91,757

$99,097

$107,025

$115,587

$124,834

$134,821

$145,607

$157,255

$169,835

Less:  Cost of Goods Sold

 

$69,930

$75,524

$81,566

$88,092

$95,139

$102,750

$110,970

$119,848

$129,436

$139,790

Gross
Profit

 

$15,030

$16,232

$17,531

$18,933

$20,448

$22,084

$23,851

$25,759

$27,819

$30,045

Less:  Selling, General & Administrative

7.80%

$6,627

$7,157

$7,730

$8,348

$9,016

$9,737

$10,516

$11,357

$12,266

$13,247

EBITDA

 

$8,403

$9,075

$9,801

$10,586

$11,432

$12,347

$13,335

$14,401

$15,554

$16,798

Less:  Depreciation

 

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

EBIT

 

$4,403

$5,075

$5,801

$6,586

$7,432

$8,347

$9,335

$10,401

$11,554

$12,798

 NOPAT (1-40% tax )

 

$2,641.87

$3,045.22

$3,480.84

$3,951.31

$4,459.41

$5,008.16

$5,600.82

$6,240.88

$6,932.15

$7,678.73

 Less capital expenditure

($45,000)

 $                  –  

 $                  –  

 $                  –  

 $                  –  

 $                 –  

 $                 –  

 $                 –  

 $                 –  

 $                 –  

 $                 –  

 Less changes in working capital

 

($12,817)

($1,471)

($1,440)

($1,527)

($1,583)

($1,641)

($423)

($431)

($438)

($446)

 Plus depreciation 

 

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

$4,000

 FCF

($45,000)

($6,175)

$5,574

$6,041

$6,425

$6,876

$7,367

$9,178

$9,810

$10,494

$11,233

 

Gas’s projections are realistic as they are
based on historical performance. For instance, the sales growth rate is
estimated at 8%, which reflects the total average historical growth in revenue
for the last five years. Likewise, the cost of sales as well as the selling and
administration expenses is taken as the average historical value for the last
five years. However, Gates should have adjusted the sales growth rate after the
first few years as it would be unrealistic to realize 8% annual growth in
revenues over one decade. 

Choice
of WACC

The choice of selected WACC reflects the
proportion of debt and capital in HPL’s capital structure. HPL cost of equity was
calculated as the risk free yield added to the risk adjusted market return
premium. The equity beta is calculated as asset beta*(1+debt/equity)=1.49.

Therefore, the cost of equity is 3.75+1.49(5%)=11.21%. The cost of debt is
7.75% which is adjusted for the credit on interest expenses, i.e. 7.75%(1-40%)=
4.65%. Therefore,  the weighted cost of
capital is 9.84%. Based on this calculation, the nearest estimate of the
representative cost of capital is 9.38% as presented in Exhibit 7. 

The main flaw of using WACC as the discount
rate is its use of book value balances as opposed to the market values. The
yields on debt as well as the firm’s market capitalization are more accurate
representations of the firms cost of capital. In addition, the proportions of the
two capital constituents are likely to changeover the forecast horizon.

Therefore, WACC presents major challenges in valuing a firm over a long
duration.

Net
Present Value

Income Statement

 

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

 FCF

 $       (45,000)

 $           (6,175)

 $            5,574

 $            6,041

 $            6,425

 $            6,876

 $            7,367

 $            9,178

 $            9,810

 $          10,494

 $          11,233

WACC

9.38%

 

 

 

 

 

 

 

 

 

 

Discount factor

 

             0.9142

             0.8358

             0.7642

             0.6986

             0.6387

             0.5839

             0.5339

             0.4881

             0.4462

             0.4462

PV of the FCF

-45000

-5646

4659

4616

4489

4392

4302

4900

4788

4683

4583

Terminal value

 

 $        269,289

 

 

 

 

 

 

 

 

 

NPV

 

$260055

 

 

 

 

 

 

 

 

 

HPL should accept project based on the
positive NPV.  The terminal value assumes
that the company will continue to grow at a perpetual growth rate of 5%. The
NPV remains positive even after increasing the cost of capital to 9.67% as per
Exhibit 7 and reducing the terminal growth rate to 1%.