Super Project

Super Project Case

1.

The relevant cash flows for General Foods are the following: sales and cost of goods sold for the Super

project, erosion of Jell-O contribution margin, selling expenses, income tax, capital expenditures,

opportunity costs for using excess agglomerator capacity, and increases in the net working capital.

a. Test-market expenses, which were included in the first period, are sunk costs because they had

been already expensed for feasibility of the Super project. Therefore, the management should not

include the test-market expenses into calculation of the cash flows.

b. The management did not include the overhead costs into the calculations, but the managerfinancial

analysis proposed to embrace the costs in Alternative 3. However, the management

should not include overhead expenses because overhead expenses affect many areas of the

business and are not attributable to a particular business activity. Only additional overhead

expenses that arise of the decision to take a project should be added.

c. As sales of the Super project displace sales of Jell-O, the management should add, and it actually

added, the erosion of Jell-O contribution margin to the cash flows.

d. As the firm plans to use the existing facilities for launching the Super project, it should deduct

from the cash flows the opportunity cost of using the facilities because the management might

have used the facilities in a best alternative way. For example, the management might have

rented or sold the existing unused facilities or it might have produced the existing or new product

using the facilities.

2.

There are three evaluation approaches suggested to evaluating capital investment decisions.

a. Incremental Basis:

In the first approach, the management considered only the incremental revenue and fixed capital

investment. Though the approach is termed as incremental basis, in reality it is not fulfilling all the

factors, considered into the incremental earnings approach. The loss associated with the best alternative

use, i.e., opportunity cost of utilizing the building and agglomerate capacity for Jell-O has not been

taken into account. Moreover, the cannibalization effect on the sales of Jell-O should also be taken into

account when calculating incremental revenues.

b. Facilities-Used Basis:

The proportion on the pro rata share basis of the cost of building and agglomerate ($453Mn) has also

been considered in incremental capital. All costs which are already incurred and don’t affect the decision

of taking a project or not, don’t need to be taken into account for evaluation of project.

Therefore, instead of considering the costs of building and agglomerate on pro rata basis, the

opportunity cost of using these facilities should be considered for calculation of incremental earnings.

Moreover, the overhead costs directly related to the existing facilities don’t need to be subtracted from

incremental earnings. This will underestimate the incremental earnings since these costs in either case

will be incurred.

c. Fully Allocated Basis:

The overhead costs represent the cost associated with the business activities which are not directly

related to the super project. Such costs can not be fully allocated to the evaluation of the super project.

Only the additional costs related to project could be considered.

3.

To evaluate the project we would