Hansson plans to use debt as the primary means of financing this expansion, and this will dramatically alter the firm's capital structure. This in turn should change the discount rate for the future cash flows, as the company's cost of capital is directly related to its firm-specific risk. The firm-specific risk for Hansson with an extra $50 million of debt on its books, and dependence on a single major customer, is going to be substantially higher than it would be under the current structure of the business. The estimates by the bank of the firm's cost of debt are dependent on the company maintaining its debt to value ratio within a specific bound, but the current WACC estimates are not going to reflect accurately the cost of debt should the firm move outside that bound, which is entirely possible with this project.
Another pitfall with using the WACC as the means of determining the discount rate is that the WACC is based on a set of assumptions. In addition to the assumption about the cost of debt being subject to the firm keeping its degree of leverage within specific, potentially unattainable parameters, the cost of equity is also subject to a set of assumptions. If Hansson was a publicly traded firm, the cost of equity could be estimated using CAPM and the firm's beta. However, because Hansson is a privately-held firm, the cost of equity must be estimated. The assumptions that are built into that estimation are critical to deriving an accurate WACC, but the fact that such assumptions need to be made weakens the value of the WACC as a tool to derive the discount rate.
With this in mind, the first step in determining the WACC needs to be to estimate a cost of debt and a cost of equity. The cost of debt has been established as 7.75% if the firm is able to keep its debt/value ratio below 25%. Hansson has a net debt level of $49.8 million at present, giving it a D/V of 9.7%; the new level post-expansion would be $107.6 million in debt for a D/V of 20.9%. It is reasonable to assume, therefore, that the cost of debt to be used in the WACC calculation is 7.75%. That the company has paid down a substantial portion of its 2003 debt level over the past several years means that it is able to take on this debt within exceeding the 25% threshold. The project is estimated to deliver positive cash flows in its first year, so there is no need to consider future, higher debt levels. More likely, the initial round of debt financing will be the peak of the firm's debt. The firm value level is also not expected to change significantly -- if anything the retained earnings will increase firm value. Thus, the 7.75% level for debt is reasonable.
For a private firm to estimate its cost of equity, the firm must select a comparable firm in the industry and use their figures to make this estimate. The estimate would then be used in the capital asset pricing model. The firm that should be used is the one that has the closest structure, risk level and size to the subject firm. The current enterprise value of Hansson is 7x last year's EBITDA. This figure is (7)*(73.5) = $514.5 million. The debt/equity ratio of Hansson at present is 20.4% using long-term debt as the figure; with the new project this figure will increase to 40.1%. The competitor with the closest enterprise value is Women's Care Company, and this company has a similar debt level at present to Hansson. Its revenues are much lower, and some of its other figures are also significantly better. WCC has a lower level of leverage as well. Another decent comparable is General Health & Beauty. GHB has a similar EBITDA, smaller net income, a similar debt level, a smaller enterprise value but a more similar D/E ratio. The betas of these two companies differ significantly. Hansson is subject to strong steady growth, which would imply a lower level of risk, but the company is set to increase its leverage and is also going to increase its dependence on a single customer. Thus, its risk profile, while currently being closer to that of WCC, is going to move towards that of GHB. As a result, it is reasonable to assume a beta in between the two comparable companies. The mean of the betas for WCC and GHB is (1.14+1.95)/2 = 1.545. Using this reasonable beta estimate for post-investment Hansson, the capital asset pricing model can be used to derive a cost of equity for the company:
Ra = Rf + B (Rf-Rm)
Ra = 3.75 + 1.545(5) = 11.475%
This can then be used to determine the weighted average cost of capital for this project:
WACC = (.604)(11.475) + (.396)(7.75) = 10%
Net Present Value
With a discount rate, the future cash flows can be discounted back. The NPV calculation is best conducted on Excel, but is based on the sum of the present value of each future cash flow. The PV of each future cash flow is calculated as follows:
PV = CF / (1+d)^t where CF = the future flow; d = discount rate and t = the year in which the flow is recorded. This delivers a net present value of:
Hansson Private Label
discount rate
0.1
Year
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Year
0
1
2
3
4
5
6
7
8
9
10
Initial Cost
-50000
Revenue
0
84960
93881
103124
112700
122618
132887
135545
138256
141021
143681
Raw Materials
0
-45120
-49400
-53760
-58200
-62720
-67320
-68000
-68680
-69360
-70040
Mfg Overhead
0
-3600
" (Traventec, Ltd., 2005) Market saturation is possible according to Traventec, Ltd., due to the constant "influx of new entrants into the low cost carrier and regional space and continued expansion of existing players. When and whether market saturation is actually reached in specific regions of the world depends on how mature regional and low cost air transport is in the first place and the size of the yet under-served
This study will incorporate consumer perceptions and attitude green products, green values, green label and green environment. Finally, it will provide insights on areas of green buying commitment and green purchasing intention (Biel, Hansson & Ma-rtensson, 2008). References Abele, E., Anderl, R., & Birkhofer, H. (2005). Environmentally-friendly product development: Methods and tools. London: Springer. Ahvenainen, R. (2003). Novel food packaging techniques. Boca Raton, FL: CRC Press Biel, a., Hansson, B., & Ma-rtensson, M.
Our semester plans gives you unlimited, unrestricted access to our entire library of resources —writing tools, guides, example essays, tutorials, class notes, and more.
Get Started Now