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The Super
Project
Group 3
Averi Chakraborty F008
Submitted to
Professor
CASE OVERVIEW............................................................................................................................................................. 3
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Case Overview
General Foods Corporation were evaluating whether they should introduce a new product called
Super, which was “a new instant dessert based on a flavoured, water-soluble, agglomerated powder”.
$200,000 was the proposed capital investment for the new project, and its production would take
place in an existing building which was used for manufacturing Jell-O, using the available capacity
of a pre-existing Jell-O agglomerator.
Super was expected to capture a 10% market share, 80% of which would come from growth in the
dessert market and 20% of which would come from the erosion of Jell-O sales
In evaluating whether the Super project would be a good investment or not, the problem of
evaluating projects based on only incremental cash flows was discussed. Crosby Sanberg, manager
of financial analysis at General Foods presented three different ways of evaluating the return on
Super.
i. The first was an incremental basis that was regularly used by General Foods in evaluating
projects. It projected that Super would fetch an attractive return of 63%.
ii. The second was a facilities-used basis, which took into account the opportunity cost of using
available, pre-existing Jell-O equipment. This method projected a return of 34%.
iii. The last approach was a fully allocated basis that included the opportunity cost and overhead
costs. This method projected a return of 25%
The dilemma for General Foods was to decide the best method for evaluating the Super project as
each method produced drastically different returns.
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1) Relevant cash flows analysis
b) Overhead expenses
This must be included in our cash flow analysis. On the basis of test market experience, General Foods
expected Super to capture a 10% share of the total dessert market. Eighty percent of this expected Super
volume would come from growth in total market share or growth in the powders segment.. This
estimated expansion of the Super Project will require extra capital and extra labour force to sustain the
increasing demand for the product.
Note:
Overhead expenses are calculated from information provided, where we subtract PBT for Facilities
Used Basis approach from Fully allocated approach and account for the 6 year average that we need.
Thus, Overhead Expense = ($211k-$157k) X 10/6 = $90k / year. This expense is accounted from
year 5 onwards
Cost of distribution system assets can be found by subtracting fixed capital amount in ‘facilities used’
approach from fixed capital in ‘fully allocated’ approach.
o Cost of distribution system assets = $673-$652 = $19k
o This cost is a part of Overhead Capital which is accounted in year 5. The depreciation on
distribution system assets = $19k-(Net Fixed Capital in ‘fully allocated’ - Net Fixed Capital
in ‘facilities used’). Therefore, total deprecation= $19k-($367-$358) = $10k. The depreciation
cost is allocated equally from 6th year. Therefore, depreciation per year = $2k
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d) Allocation of charges for the use of excess agglomerator capacity
The allocation of charges for the use of excess agglomerator capacity is not relevant if we are evaluating
the project from a short-term perspective that is when the excess capacity of the Jell-O agglomerator is
enough to meet the present demands of Super.
Since this capex has already been taken into account during the Jell-O investment, taking it partially into
account without removing it from the Jell-O valuations would lead to double counting. Even if we do
remove it from the Jell-O account it will just be an accounting manoeuvre and it won’t have any effect
on the company as a whole.
But from a long run perspective the partial allocation of charges will help us understand the actual rate of
return we would get while investing in a new agglomerator while increasing capacity for the Super
project.
Annual Sales
Annual Sales - Estimated
(In thousands, $000)
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Units 1100 1200 1300 1400 1500 1500 1600 1600 1700 1700
Unit price $2 $2 $2 $2 $2 $2 $2 $2 $2 $2
Sales $2,200 $2,400 $2,600 $2,800 $3,000 $3,000 $3,200 $3,200 $3,400 $3,400
Deductions $88 $96 $104 $112 $120 $120 $128 $128 $136 $136
Net Sales $2,112 $2,304 $2,496 $2,688 $2,880 $2,880 $3,072 $3,072 $3,264 $3,264
Annual Costs
Cost of capital
Assumption: Yield of Long term Notes = Average US Treasury 10 yr rate in 1968 + Yield spread
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Average US Treasury 10 yr rate in 1968= 5.65%
Yield Spread = 2%
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Net Cash Flows
ROFE 44.65%
Outcome:
Conclusion:
In the short run, the project looks lucrative as the NPV is positive and IRR is also greater than the discount
rate. With payback period of 7.04 years and ROFE of 44.65% the project should be considered for
investment in the short run.
This approach also takes into account the pro rata cost of agglomerator and building which is utilised for the
production of Super. Recognizing that Super will use half of an existing agglomerator and two-thirds of an
existing building, which were justified earlier in the Jell-O project, we added Super’s pro rata share of these
facilities ($453M) to the incremental capital. However, these costs should be subtracted from valuation of
Jell -O to avoid double counting.
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Pro Rata Share
Total= $453k
Depreciation of Facilities
The Jell-O facilities undergo a total depreciation of $295k in 10 years. In our calculations we have assumed
depreciation to be same for all the 10 year periods. Thus, depreciation per year = 295/10 = $29.5k
ROFE 21.24%
Outcome:
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The NPV of the project is negative at -$280.53k
The IRR of 3.33% is less than the cost of capital which is 8.59%
The payback period is less than 10 years at 8.85 years
The ROFE of 21.24% is just above the threshold rate of 20%
Conclusion:
The payback period and ROFE are not the appropriate methods to evaluate capital projects as both these
methods do not take into account the effect of time value of money (TVM). For instance, in the long term
analysis of the Super Project the payback period comes out to be less than 10 years and ROFE is also above
the acceptable limit of 20% which makes the project look profitable. However, the NPV is negative and IRR
is less than the cost of capital so we can conclude that this project is not feasible for investment in the long
run.
b) Potential Risks
Might be less lucrative when dedicated agglomerator required:
o If the demand of Super increases to the point that we need another agglomerator then the
decision to keep on producing Super might seem less lucrative.
o If the rate of using the agglomerator remains the same as per our calculations, in the long run
producing Super might lead to lower margins (like in the case of Tasty) as seen in the option
3 which had a negative NPV of 280.53k and an IRR of only 3.33% which was much less than
the required rate of return i.e. 8.59%
Risk of excess cannibalisation of the market share of Jell-O:
o Presently as per the test market experience Super is expected to capture a 10% market share
of the dessert market but 2% of that market share will come from eroding the share of Jell-
O’s market. If this cannibalisation doesn’t stop there it can lead to a problem for the Jell-O
division.
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4) Should General Foods proceed with the Super project? Why or
why not?
Yes, General foods should proceed with the Super project as it will lead to a incremental sales and start
generating profits from the fourth year. The corresponding NPV is also highly positive ($ 90.73k) with an
IRR of 11.12% well above the desired rate of return of 9.25% within the time horizon of 10 years while
utilizing the excess capacity of Jell-O’s agglomerator.
5) References
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