4024
REV: MARCH 1, 2010
TEACHING NOTE
ERIK STAFFORD
JOEL L. HEILPRIN
Hansson Private Label, Inc.:
Evaluating an Investment in Expansion
Case synopsis
This case of a potential expansion opportunity at Hansson Private Label (HPL), a midsize
producer of private label personal care products, is intended to teach undergraduate and first-year
MBA students the basics of capital budgeting analysis. It assumes a basic understanding of financial
statements, cash flows, and the time value of money. Familiarity with the weighted average cost of
capital (WACC) and the derivation of discount rates is helpful but not required.
The HPL case requires students to synthesize financial information provided by different
operating departments into a set of projected, unlevered free cash flows (FCFs). Students must then
choose the correct discount rate and determine the project’s net present value (NPV). The case also
provides instructors with the opportunity, time permitting, to explore other topics, including
economic value added (EVA) and value additivity.
,4024 | Teaching Note—Hansson Private Label, Inc.: Evaluating an Investment in Expansion
Pedagogical Objectives
1. Define and derive debt-free cash flows
2. Critically analyze the assumptions underlying financial projections
3. Learn the role of the opportunity cost of capital when making capital budgeting decisions
4. Calculate NPV and analyze its sensitivity to project variables
5. Learn alternative methods of project evaluation
Potential Questions for Students
1. How would you describe HPL and its position within the private label personal care
industry?
2. Using assumptions made by Executive VP of Manufacturing, Robert Gates, estimate the
project’s FCFs. Are Gates’ projections realistic? If not, what changes might you incorporate?
3. Using CFO Sheila Dowling’s projected WACC schedule, what discount rate would you
choose? What flaws, if any, might be inherent in using the WACC as the discount rate?
4. Estimate the project’s NPV. Would you recommend that Tucker Hansson proceed with the
investment?
Overview of Hansson Private Label
As a prelude to discussing the wisdom of Hansson’s potential investment, instructors should lead
students through a brief précis of HPL’s situation. It should cover HPL’s size, growth, profitability,
and ownership structure vis-à-vis the peer group, as illustrated in Exhibits 6 & 7. The goal is to have
students consider, as part of the evaluative process, how reasonable the proposal’s operating
assumptions and risks are. The main points of interest are these:
• Given the comparable company information, HPL ranks in the middle of the pack in terms of
revenue. Notably, however, competitors Christine Sinclair and Skin Care Enterprises are more
than twice the size of HPL.
• In terms of profitability, HPL’s EBITDA margins significantly lag those of its competitors.
Exhibit 1 shows that even in its best year, HPL was not as profitable as its peers.
• Exhibit 1 also reveals that HPL has been able to grow its top line at a 7.8% compound annual
rate, which greatly exceeds the industry growth rate. Although the case does not identify
what’s driving HPL’s revenue growth, it is reasonable to conclude that the firm may have
made the choice to grow revenues at the expense of its operating margins.
• Finally, Exhibit 8 shows that HPL typically employs less leverage than its peers, undoubtedly
because of the firm’s ownership structure. The concentration of Tucker Hansson’s personal
wealth in HPL has made him more risk-averse than a well-diversified investor would be.
Some students are likely to consider this factor when choosing a discount rate.
2
, Teaching Note—Hansson Private Label, Inc.: Evaluating an Investment in Expansion | 4024
Strategy
Although a complete strategic analysis is beyond the scope of this case, it may be worthwhile to
start by spending a few minutes discussing the motivation(s) behind the possible expansion. Remind
students that the quality of information and the motives of those supplying it are of paramount
importance when making economic decisions.
Nevertheless, the wisdom of the proposed expansion is somewhat ambiguous, in spite of the
capacity commitment from the company’s largest customer. The case makes clear that manufacturers
in this industry depend heavily on a small number of national retailers that presumably have
significant channel power. Furthermore, unit volume within the industry is growing at a very modest
rate of less than 1%. According to Gates, the inroads made by private label brands were not sufficient
to support expansion by multiple producers. Given these facts, some students might conclude that
the industry has ample, even excess, capacity. Thus, it is not clear how HPL would fill the additional
capacity not utilized by its primary customer. Moreover, Hansson might elicit a response from other
industry participants that would expose the firm to competitive pressures.
Once students have broadly considered HPL as an organization and some of the strategic
implications of the expansion, instructors should move the discussion forward. Students can revisit
these issues after examining the projected cash flows and the likely NPV.
Net Present Value and Cash Flows
If students have not yet been exposed to the concept, they should be introduced to the idea of
modeling a project as a series of expected future cash flows, which are then discounted at the
opportunity cost of funds, r (see the formula below). Students will undoubtedly grasp this concept
quickly but should be reminded that this approach to valuation is based solely on the amounts,
timing, and risks of the estimated cash flows, including the initial investment. Also note that non-
cash benefits are not measured within this framework. As a result, some managers, possibly
including those at HPL, may argue that an NPV analysis will not capture some of the strategic or
competitive aspects of a project because their cash flows are not easily measured.
To address this issue, instructors may want to ask students whether an NPV model can
adequately capture strategic and competitive benefits. Again, some students are likely to argue that it
cannot. Instructors should remind students of this point:
Companies are organized for the purpose of wealth maximization, which is always a function of cash
flow. If a sustainable competitive advantage is created, it should be reflected in the probabilities of
expected future cash flows.
In other words, if a strategic benefit doesn’t contribute to wealth maximization, it’s not really a
benefit. Indeed, the non-cash benefits associated with assets and organizations are those not designed
for wealth maximization, which NPV may not estimate well. For example, works of art or nonprofit
charities provide utility beyond the scope of wealth maximization.
With that equation on display for students, instructors may want to point out some additional
considerations:
3
REV: MARCH 1, 2010
TEACHING NOTE
ERIK STAFFORD
JOEL L. HEILPRIN
Hansson Private Label, Inc.:
Evaluating an Investment in Expansion
Case synopsis
This case of a potential expansion opportunity at Hansson Private Label (HPL), a midsize
producer of private label personal care products, is intended to teach undergraduate and first-year
MBA students the basics of capital budgeting analysis. It assumes a basic understanding of financial
statements, cash flows, and the time value of money. Familiarity with the weighted average cost of
capital (WACC) and the derivation of discount rates is helpful but not required.
The HPL case requires students to synthesize financial information provided by different
operating departments into a set of projected, unlevered free cash flows (FCFs). Students must then
choose the correct discount rate and determine the project’s net present value (NPV). The case also
provides instructors with the opportunity, time permitting, to explore other topics, including
economic value added (EVA) and value additivity.
,4024 | Teaching Note—Hansson Private Label, Inc.: Evaluating an Investment in Expansion
Pedagogical Objectives
1. Define and derive debt-free cash flows
2. Critically analyze the assumptions underlying financial projections
3. Learn the role of the opportunity cost of capital when making capital budgeting decisions
4. Calculate NPV and analyze its sensitivity to project variables
5. Learn alternative methods of project evaluation
Potential Questions for Students
1. How would you describe HPL and its position within the private label personal care
industry?
2. Using assumptions made by Executive VP of Manufacturing, Robert Gates, estimate the
project’s FCFs. Are Gates’ projections realistic? If not, what changes might you incorporate?
3. Using CFO Sheila Dowling’s projected WACC schedule, what discount rate would you
choose? What flaws, if any, might be inherent in using the WACC as the discount rate?
4. Estimate the project’s NPV. Would you recommend that Tucker Hansson proceed with the
investment?
Overview of Hansson Private Label
As a prelude to discussing the wisdom of Hansson’s potential investment, instructors should lead
students through a brief précis of HPL’s situation. It should cover HPL’s size, growth, profitability,
and ownership structure vis-à-vis the peer group, as illustrated in Exhibits 6 & 7. The goal is to have
students consider, as part of the evaluative process, how reasonable the proposal’s operating
assumptions and risks are. The main points of interest are these:
• Given the comparable company information, HPL ranks in the middle of the pack in terms of
revenue. Notably, however, competitors Christine Sinclair and Skin Care Enterprises are more
than twice the size of HPL.
• In terms of profitability, HPL’s EBITDA margins significantly lag those of its competitors.
Exhibit 1 shows that even in its best year, HPL was not as profitable as its peers.
• Exhibit 1 also reveals that HPL has been able to grow its top line at a 7.8% compound annual
rate, which greatly exceeds the industry growth rate. Although the case does not identify
what’s driving HPL’s revenue growth, it is reasonable to conclude that the firm may have
made the choice to grow revenues at the expense of its operating margins.
• Finally, Exhibit 8 shows that HPL typically employs less leverage than its peers, undoubtedly
because of the firm’s ownership structure. The concentration of Tucker Hansson’s personal
wealth in HPL has made him more risk-averse than a well-diversified investor would be.
Some students are likely to consider this factor when choosing a discount rate.
2
, Teaching Note—Hansson Private Label, Inc.: Evaluating an Investment in Expansion | 4024
Strategy
Although a complete strategic analysis is beyond the scope of this case, it may be worthwhile to
start by spending a few minutes discussing the motivation(s) behind the possible expansion. Remind
students that the quality of information and the motives of those supplying it are of paramount
importance when making economic decisions.
Nevertheless, the wisdom of the proposed expansion is somewhat ambiguous, in spite of the
capacity commitment from the company’s largest customer. The case makes clear that manufacturers
in this industry depend heavily on a small number of national retailers that presumably have
significant channel power. Furthermore, unit volume within the industry is growing at a very modest
rate of less than 1%. According to Gates, the inroads made by private label brands were not sufficient
to support expansion by multiple producers. Given these facts, some students might conclude that
the industry has ample, even excess, capacity. Thus, it is not clear how HPL would fill the additional
capacity not utilized by its primary customer. Moreover, Hansson might elicit a response from other
industry participants that would expose the firm to competitive pressures.
Once students have broadly considered HPL as an organization and some of the strategic
implications of the expansion, instructors should move the discussion forward. Students can revisit
these issues after examining the projected cash flows and the likely NPV.
Net Present Value and Cash Flows
If students have not yet been exposed to the concept, they should be introduced to the idea of
modeling a project as a series of expected future cash flows, which are then discounted at the
opportunity cost of funds, r (see the formula below). Students will undoubtedly grasp this concept
quickly but should be reminded that this approach to valuation is based solely on the amounts,
timing, and risks of the estimated cash flows, including the initial investment. Also note that non-
cash benefits are not measured within this framework. As a result, some managers, possibly
including those at HPL, may argue that an NPV analysis will not capture some of the strategic or
competitive aspects of a project because their cash flows are not easily measured.
To address this issue, instructors may want to ask students whether an NPV model can
adequately capture strategic and competitive benefits. Again, some students are likely to argue that it
cannot. Instructors should remind students of this point:
Companies are organized for the purpose of wealth maximization, which is always a function of cash
flow. If a sustainable competitive advantage is created, it should be reflected in the probabilities of
expected future cash flows.
In other words, if a strategic benefit doesn’t contribute to wealth maximization, it’s not really a
benefit. Indeed, the non-cash benefits associated with assets and organizations are those not designed
for wealth maximization, which NPV may not estimate well. For example, works of art or nonprofit
charities provide utility beyond the scope of wealth maximization.
With that equation on display for students, instructors may want to point out some additional
considerations:
3
