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Super Project Essay

1248 words - 5 pages

The Super Project

• Case Summary • Problem Statement • ROFE & Capital Budgeting • Incredible Incremental • Analysis Options • Cash Flows • Recommendations

Case Summary
• General Foods is a large corporation organized by Product Lines. • Super is a proposed new instant desert, based on a “flavored, water-soluble, agglomerated powder.” • General Foods has numerous projects with strict criteria to judge worthiness. • There are basically three types of Capital Investment proposals at General Foods: Safety, Quality, Increased Profit • Increased Profit: Cost Reduction, Capacity, New Product • Max 10 years payback: as low as 20% PBT • … if expected to be permanent product ...view middle of the document...

• Artificially biases long-term asset-intensive projects, as they have bigger apparent depreciation cash flows •Does not capture the time value of money; interest and inflation ROFE is not a tool to evaluate capital projects. Even used as a metric to compare capital earnings performance, has flaws.

Capital Budgeting
In Capital Budgeting you do not evaluate earnings, you evaluate cash flows. Why?
“You can’t spend out of earnings, you can’t eat out of earnings, and you can’t pay dividends out of earnings. You can do these things only out of cash flow.” - Ross, Westerfield, Jaffe To evaluate cash flows, we must account for the time-value of money: Discount future cash flows for interest and inflation. How?

NPV Which Cash Flows?
Capital Budgeting is specifically about Incremental Cash Flows “[Incremental cash flows are] the changes in the firm’s cash flows that occur as a direct consequence of accepting the project” - Ross, Westerfield, Jaffe

Decisions Decisions
•Capital budgeting decisions about Super contain externalities •Cost of the market study •Facilities used from the Jell-O project •SG&A overhead for GF corporate •Confusion about how to make these decisions •The GF Accounting and Financial Manual specifies, “capital project requests be prepared on an incremental basis.” •“What I learned about incremental analysis at the Business School doesn’t always work.” - Crosby Sanberg, GF •“Although the existing facilities utilized by Super are not incremental to this project, they are relevant.” - Crosby
Sanberg, GF

•If you add non-incremental items to Super, shouldn’t you balance the equation and account for changes to the Jell-O project? •Where do you draw the line? Should not be arbitrary. •To make good decisions, a well defined framework is required to reliably apply rules to decision making

Incredible Incrementals
Incremental Analysis
It is important to determine which cash flows are incremental and which are not because non-incremental cash flows are not relevant to the project. How do we know which cash flows are incremental cash flows? Incremental Cash Flow = total firm cash flow WITH the project total firm cash flow WITHOUT the project

Source: Professor Tim Thompson, Kellogg School of Management

Incredible Incrementals
Examine cash flows decisions • • • • • • • • • Changes in net working capital Capital Expenditures for fixed assets Depreciation is not cash flow, but must be factored into taxation Ignore sunk costs Include effects of the project on the rest of the firm: erosion or enhancement Include Overhead costs Account for opportunity costs Recaptured working capital recovered after shutdown Net proceeds (after taxes) from salvage value due to the sale of capital assets after shutdown

Summary Option 1

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