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 isnt 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
HPLs 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 HPLs 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 isnt
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 hasnt 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.