Hansson Hints Valuation Spring 2020 PDF

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Hansson&Case&“Hints”&& Hansson&Private&Label&Group&Case& Submission Process: • Put your group members’ names on Page 1 of the document. • Only one person in the group should submit the teams’ files on Blackboard before the start of class on 2/11. Please format your 2 page deliverable as a PDF with excel exhibits in the appendix. You may also upload your excel spreadsheets along with you memo (but I prefer to see the main calculations in your pdf memo). If you have never performed an NPV, IRR, payback calculation in excel you may want to review the excel spreadsheet with the NPV and Project Greenlight examples. The purpose of the case analysis is for groups to perform analysis of a real world capital budgeting case. This is a review of concepts covered in the intro corporate finance and accounting courses. The case also includes a WACC (already calculated by the case writer), financial statements and comparable public companies. When we have our class discussion I hope we can encourage debate as to what Hansson should do and what makes strategic sense – whether he should accept or decline the project. This should include a discussion of the risks of accepting the project and other potential options and/or opportunities if you recommend declining the expansion. Please address the following questions in your memo for the Hansson Private Label case: • How would you describe HPL and its position within the private label personal care industry? Evaluate HPL’s historical financial performance (Exhibit 1). How has the company performed? Consider analysis of financial performance ratios and peer benchmarking (Exhibit 6). To calculate ROIC in the Hansson case: NOPLAT/Total Invested Capital for each year. IC includes AR+Inv-AP+PPE. For the PPE in each projected year of the project it decreases by the amount of depreciation. The company’s historical ROIC averages out around 12%. For the project it varies. • Using Exhibit 5 Excerpt of Financial Assumptions in Capital Request Form, estimate the project’s Free Cash Flows. Are the projections realistic? To evaluate this your group might compare the projected ROIC and EBITDA margins to historical performance. • Utilizing the data provided in the exhibits, determine whether the project is attractive in strategic and economic terms. Calculate the total project cash flows, NPV, and IRR, given the supplied project forecasts. Perform basic sensitivity analysis on some of the key drivers of the cash flows. • Would you recommend that Hansson proceed with the investment? Will the expansion position HPL for any form of sustainable competitive advantage? Will it allow HPL to improve long-term profitability? • If you recommend declining the proposal, what practical alternatives and options do you recommend? • What are the risks of the investment? What might be done to mitigate these risks?

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Hansson&Case&“Hints”&& Hansson&Private&Label&Group&Case& Case Calculations: • Your group must set up an NPV analysis of the project. Refer to the discussion of the Investment Proposal. I have also posted a spreadsheet on Blackboard with exhibits so you do not need to re-enter the key data from the case exhibits. • The Year 0 Initial Investment will be $45,000 (Facility Expansion, Manufacturing Equipment, and Packaging Equipment. Assumptions have been provided for depreciation and maintenance expenses. The following is taken from page 3 of the case.

For purposes of calculating the 10-year project free cash flow (2009-2018) I have provided my 2009 (first year) calculation. There are a few typos/discrepancies in the HBS case writers’ data. 1) For manufacturing overhead in 2009, the case shows $3,600, but the HBS excel file shows $3,920. If we use $3,920 it gets us to the case writers' NWC number, $12,817. 2) The number of managers under Salaried Labor Costs in the spreadsheet is also different from the case. This has an impact on total labor cost. I am not concerned with the differences here. If you set up your cash flow as I have below then you should be fine: Operating Results: Revenue Less: Raw Material Costs Less: Labor Expense Less: Manufacturing Overhead Less: Maintenance Expense Less: Selling, General & Administrative Expense EBITDA Less: Depreciation EBIT Less: Taxes NOPAT Un-Levered Free Cash Flow: NOPAT Plus: Depreciation Less: Change in Working Capital Un-Levered Free Cash Flow

2009 84,960 45,120 18,640 3,920 2,250 6,594 8,436 4,000 4,436 1,774 2,662 2,662 4,000 12,817 (6,156)

Note: Some textbooks defines Inventory Turnover = Cost of Goods Sold / Inventory Days’ Sales in Inventory = 365 / Inventory Turnover. However in the Hansson case it is calculated differently. For consistency let’s follow the case instructions and the calculations shown below.

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Hansson&Case&“Hints”&& Hansson&Private&Label&Group&Case& If you are having difficulty with the change in working capital portion of the assignment, please refer to the definition of DSO, DPO and DSI used in the case:

Projecting the working capital accounts is simply a matter of algebraic manipulation. For example, if the assumption for DSO is 47.6x, then to project the amount of accounts receivable needed for the first year in the project (2009) it would be: DSO= Ending Receivables/(Sales/360 days) A/R=(DSO/360) x Sales 11,223=(47.6/360) x 84,960 DSI= Ending Inventory/(Sales/360 days) Inventory= (DSI/360) x Sales 8,865=(37.562/360) x 84,960 DPO=(Ending Accounts Payable/Cash Operating Expenses/360) Accounts Payable= (DPO/360) x Cash Operating Expenses* 7,270=(34.2/360) x 76,524 *Cash Operating Expenses includes Raw Material Costs, Labor Expense, Manufacturing Overhead, Maintenance Expense, Selling, General & Administrative Expense.

The increase in working capital is not expected to occur up front at the time of the initial investment. It is assumed to take place throughout the first year and should be considered as part of the 2009 cash flows. You will notice that going from working capital of 0 in year 0 to 12.8 million in year 1, the first year of Un-Levered Free Cash Flow for the project will subtract a “use” of cash of 12.8 million. As a reminder, Net Working Capital is calculated by taking current assets (Accounts Receivable and Inventory) less current liabilities (Accounts Payable). The Change in Working Capital is from one period to the next and shows the cash flow impact. In each subsequent year 2010-2018 the amount subtracted will be much less since working capital will have already been established in the first year and you will just evaluate the change (increase) in net working capital. According to the footnote in the case on page 3, at least some portion of net working capital will be returned to investors at the end of the project in 2018. The return of working capital is equal to the balance of accounts receivable less accounts payable (at the end of 2018). According to the case assumptions, inventory is assumed to be worthless. Because the property, plant, and equipment is specialized and almost completely depreciated, it is assumed to be worthless. You will need to discount the return of the net working capital (source of cash) back to present along with the project cash flows.

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Hansson&Case&“Hints”&& Hansson&Private&Label&Group&Case& The Weighted Average Cost of Capital (WACC) given in the case is 9.38%. This can be used as the discount rate “r” for the NPV analysis (this was the cost of capital calculated in exhibit 7 for a 20% Debt/Value assumption). This article might be of interest as we discuss private label: Inside the secret world of Trader Joe's http://tinyurl.com/297usn3

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