Hansson Private Label, Inc.

:
Evaluating an Investment in Expansion
A Case Study from the Harvard Business School

Presented to the
Accountancy Department
De La Salle University

In Partial Fulfillment of
The Course Requirements in
ACFINA2 K32

Albano, Reynald Joshua C.

Guingcangco, Christian Mark
Laguatan, Charlie Sergie
Lapuz, Carl Jay A.
Singian, Gemar

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
sub segments. 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),
Sheila 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%.

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.
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 unfavorable 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.
Conclusion
Hanson Private Label, Inc. (HPL), a manufacturing company of
personal care products, is considering a three-year contract from its largest
retail customer that could give a significant rapid growth and value for the
company. However, in order to comply with the demands of the contract, the
company would need to expand its production facilities, thus introducing
significant risks which would involve not only the company but also Hansson
himself, and would close off all other investment opportunities for the near
future.
Due to the firms goal of being the leading provider of high quality
private label personal care products to Americas leading retailers, it is
important to take note that the three-year contract, which could give a
significant rapid growth and value for the company, could lead to a huge step
up in achieving the goal and be the leading provider themselves. It is also
important to take note of the risks involved, where the company will have to
incur a high level of debt to finance the project.
As seen in the exhibits presented, the NPV, MIRR, and the PI of the
project is accepted, and shows that the benefits outweigh the costs, although
the payback period shown may be seen as good or bad depending on their
standard payback period for projects, as it will benefit them long-term. Also, it

is probable that if HPL declines the offer, another company may choose to
accept it which would then lead to an unfavorable outcome for HPL. Due to
these circumstances, our group recommends that Hansson Private Label, Inc.
should take this opportunity to expand and accept the contract.