Corporate Finance FINC-GB.2302.

70

Anjolein Schmeits

The Super Project

Team: David Knapp, Andrew Petrozziello, Carlo Nardone, Cheng Shen, Ge Wu, Ankit Mehta

Based on financial analysis of the Super Project and General Foods Corporation criteria (illustrated in
exhibit 3), we recommend that Global Foods Corporation must proceed with the project for reasons
explained below. Super food project was subjected to financial evaluation as per General Food s
Corporation investment analysis process.
Per the financial analysis from F1968 through F1977, following investment measures were determined:
General Foods Corporation must accept the Super project as the Net present value for the Super Project
is a positive $412.87 million, with cost of capital at 10%. Super project will thus increase the firm value
and subsequently the shareholder value.
Internal rate of return is 27.4% (Exhibit 1) is greater than the cost of capital of 10% to General Foods
Corporation. Thus, General Foods Corporation must accept the project. Internal rate of return can be
artificially high if the projects are shorter or if the initial cash flows are higher.
Accounting rate of return for the super project based on 10-year average is 30.49% (post taxes).
Accounting rate of return are computed by dividing average after tax profits ($116 million) by average
invested capital ($380 million). Accounting rate of return is based on accounting profits and does not take
into account the time value of money.
(Discounted) Payback Period for the super project is 6.83 years. General Foods Corporation will take
6.83 years of nominal cash flows to recover the initial outlay of the project.
Criteria for Evaluating Projects by General Foods Corporation:
Based on the criteria, Super is classified as profit increasing projects. Estimates of payback period and
return on funds employed are required for this project based on its initial outlay. Projects with a payback
period of upto 10 years and a 10- year return on funds as low as 20% PBT (profit before taxes) are
considered worthy of consideration.

Risk and Benefits of the Super Project

General Foods Objective: To find good solid projects to employ capital at an attractive return on
investment. The rate of capital inputs must be balanced against a steady growth in earnings per share. The
key to General Foods Corporation capital budgeting is to integrate the plans of 8 divisions into balanced
company plan which meets overall growth objective.
Benefits:
A super food, a new instant dessert, doubles the powered dessert business category; it increases
the Division business by 10% by capturing 10% share of total dessert market.
If accepted, incremental investment is low, as Super will utilize existing building and available
excess agglomerator capacity, thus maximizing resource utilization.
80% of sales of Super volume would come from growth in total market share or growth in
powders segment and only remaining 20% from Cannibalization of its existing product.

Corporate Finance FINC-GB.2302.70

Anjolein Schmeits

As per the forecast, Super project exhibits net loss in first three years and profits in following
years, however general foods are big enough to introduce new products without showing a loss.

Risks:
As a result of Super project, there is an opportunity loss of existing facilities, as new facilities
must be built to accommodate future General Foods expansion. As General Foods business
expands, Super utilizes facilities that are adaptable to alternative uses in an expanding business.
With future growth and expansion, Super project will require much larger investments to meet
high volume demand as current infrastructure will not be able to meet long term demands
for the product.
If Jell-O product demand increases significantly in short term, it will impact production capacity
of the Super.
If General Foods reject the Super Project, a competitor product can capture the dessert market
share and also potentially erode Jell-Os earnings.
Relevant cash flows for General Foods to use in evaluating the Super Project are after-tax incremental
project cash flows based on with-or-without capital budgeting method. Following assumptions were
made in financial analysis of the Super Project:
1. Capital expenditure of $200 million was expensed at time zero i.e. F1968.
2. Test marketing expense of $360 million was added back to the EBIT as it is sunk cost. Cash
flow associated with sunk cost should not be considered for capital budgeting as they are not
incremental and cannot be recovered. Sunk costs are past and irreversible cash outflows and thus
cannot affect the decision to accept or reject a project.
3. Overhead expenses of $54 million (difference of profit before taxes between Facilities used
bases and fully allocated) directly related to the Super project must be considered for capital
budgeting. Overhead costs include manufacturing costs, plus selling and general and
administrative costs on a per unit basis and are subtracted from the incremental revenue.
Overhead capitals also include a share of the distribution system assets.
4. Allocation of charges for the use of excess agglomerator capacity was not included in the
capital budgeting. Excess agglomerator capacity is already accounted in the production of Jell-O.
Per the case, there is no current alternative use of the excess Jell-O aggloemerator capacity and
thus there is zero opportunity cost.
5. Erosion of Jell-O contribution margin has been included in the capital budgeting as these are
classified as incidental effects or side costs. While determining future cash flows it is important to
consider projects effect on the firms business. Demand for the Super will cannibalize existing
Jell-O sales. This incidental effect needs to be factored into the incremental cash flows.