Project Financial Analysis, Cash Flow, NPV, and Sensitivity Analysis

This assignment analyzes an investment project for Hansson Private Label (HPL) Limited, evaluating its financial viability. The analysis includes the estimation of free cash flows over a 10-year period, calculation of the weighted average cost of capital (WACC), and determination of the net present value (NPV). The document also performs sensitivity analysis to assess the project's vulnerability to changes in key variables such as revenue growth, raw material costs, and manufacturing overhead. The analysis concludes with a recommendation on whether HPL Limited should proceed with the investment, considering the project's potential and associated risks. The assignment includes a detailed memo and supporting exhibits to justify the financial analysis.

To
Tucker Hansson
From: XXX
Date: XX February, 2008
Subject: Project financial analysis, cash flow estimation, computation of net present value and
sensitivity analysis
1. Free Cash flows of the project:
The project is expected to last for 10 years and using the assumptions given for coming 10 years,
project’s free cash flows for the next 10 years is as under:
Year Cash flow
0 (45,000)
1 (7,338)
2 6,785
3 7,608
4 8,683
5 9,590
6 10,764
7 11,056
8 11,350
9 11,647
10 24,764
2. Weighted average cost of capital:
WACC, i.e. Weighted average cost of capital, is the cost of capital that the company incurred for the
funds being deployed by the company in business. WACC, as the name suggests, is the weighted
average of the cost of capital for various sources of fund, i.e. debt, equity, preference share capital,
etc.
As per the given assumptions, new estimated debt equity ratio of the company is 20.9%, i.e. total
capital of the company would include 20.9% of debt and 79.1% of equity.
Thus, in order to compute the weighted average cost of capital, we require the cost of equity and
cost of debt, using these numbers, the weighted average cost of capital is 12.08%. (Refer exhibit 2)

3. Net present value:
Net present value is the sum of cash flows generated from the project, discounted at the applicable
discount rate, determined on the basis of weighted average cost of capital of the project/company.
4. Sensitivity analysis:
Based on 10 year forecast, the net present value computed in part 3, is sensitive to various factors,
such as growth in revenue, raw material cost, manufacturing overhead, etc. which would directly
impact the per unit margin of the product sold or the quantity of the product sold, directly affecting
the free cash flows of the company.
Capacity utilization of the factory is estimated to increase gradually and reach the maximum level of
85% from 2014 onwards, in case the capacity utilization reaches 10%, it would lead to an additional
overall contribution being generated by the company. This additional contribution will result in the
NPV of the project being $ 15,632, i.e. the NPV of the project will become positive, as a result of
increase in number of units sold. (Refer excel file)
5. Should HPL Limited invest in the project?
As per the assumptions given in the problem, it is not advisable to proceed with the investment.
But in case the management of the company, feels that based on market conditions the company
can reach the capacity utilization higher than 85% and
generate a contribution margin higher than present, it may go for investment in the project, but that
would depend on the
estimates that the company would have about the revenues and number of units produced.