4- 1

The Super Project

Cash Flow Estimation for Capital
Budgeting

4- 2

Investment Criteria
Project ranking according to
Payback period
Accounting rate of return

Are certain costs being ignored?

What are the relevant project costs and cash
flows?
Test-market expenses
Use of excess agglomerator and building capacity
Overhead costs
Lost contribution margin on Jell-O

4- 3

Test Market Expense

R&D

Product
Design

Market
Testing

Manufacturing
Investment

Working
Capital

4- 4

Allocated Charges for Capacity

Utilization
Charge for excess agglomerator and building
capacity
Jell-O sales for August to September 1966
increased by 40% over previous year
In two years you would have to increase capacity
anyway
Super project will require earlier and even greater
increase

Reasonable to include use as costs

Risk of investment?

4- 5

Allocated Overhead Charges

Overhead costs are not fixed (see last 10 yrs in
Exhibit 3)

SGA/Sales: 17.9% (1958) to 27.2% (1967)

Reasonable to include an increase from years 5 to 10

How much?
Costs increase by $54,000/year for 10 years
Total of $540,000
Yearly cost from years 5-10 = $540,000/6
$90,000

Graduated scale?

4- 6

Charge for Lost Contribution

Questionable charge
Assume that Jell-O would hold volume if
Super is not introduced
What if a competitor introduces a product like
Super?
Erosion is inevitable?

4- 7

Assumptions and setup

Exclude:
test market expense (sunk cost)
erosion (inevitable)

Include:
agglomerator and building use (opportunity cost)
overhead costs (side effect)

cash flow identity

cash (project) = OCF - additions to NWC - NCS
Assume r=10%

4- 8

Cash Flow from Operations

Year
1
Net sales
$2,112
COGS
$1,100
Gross profit
1,012
Advertising expense 1,100
Increased overhead
Depreciation
46
Start-up costs
15

2
$2,304
$1,200
1,104
1,050

3
$2,496
$1,300
1,196
1,000

4
$2,688
$1,400
1,288
900

43

41

($149)
(77)

$11
6

Net Profit
Depreciation

(72)
65

Cash flow

(7)

Profit before taxes

Taxes (@52%)

38

5
$2,880
$1,500
1,380
700
90
35

6
$2,880
$1,500
1,380
700
90
33

7
$3,072
$1,600
1,472
730
90
30

8
$3,072
$1,600
1,472
730
90
26

9
$3,264
$1,700
1,564
750
90
24

10
$3,264
$1,700
1,564
750
90
21

$155
81

$350
182

$555
289

$557
290

$622
323

$626
326

$700
364

$703
366

5
61

74
58

168
54

266
50

267
46

299
42

300
37

336
34

337
30

$66

$132

$222

$316

$313

$341

$337

$370

$367

Depreciation for Jell-O facilities: Sum-of-year digits; 40/15 year lives; $133/320

4- 9

Cash Flows for Super

Year New P&E Jell-O Facilities Working Capital CF Operations Total Cash Flows
0
($200)
($453)
$8
($645)
1
($329)
(7)
(336)
2
55
66
121
3
3
132
135
4
7
222
229
5
23
316
339
6
(1)
313
312
7
(13)
341
328
8
0
337
337
9
(12)
370
358
10
0
367
367
11
31
60
267
358
Investment tax credit of $8 in year 0; Tax shield on write-off of equip. in yr 11

4- 10

DCF Calculation
Year Cash Flow Discount
0
0
1/(1.1)
=1
$645

1
0.909
$336
2
$121
0.826
3
$135
0.751
4
$229
0.683
5
$339
0.621
6
$312
0.564
7
$328
0.513
8
$337
0.467
9
$358
0.424
10
$367
0.386
11
$358
0.350

PV
$645
$305
100
101
156
211
176
168
157
152
142
125

NPV = $538 = accept

4- 11

NPV Profile of Project

2500
2000

NPV

1500

IRR = 18.5%

1000
500
0
0

10

15

-500
Discount rate

20

25

Sensitivity Analysis
Use of Jell-O Facilities

4- 12

Ye a r
0
1
2
3
4
5
6
7
8
9
10
11
Tota l

De precia tion Ta x
PV of
Ex pe nse
She lte r
Ca sh Flow
Foregone
Foregone a t 10%
$453
$46
$24
(22)
43
22
(18)
41
21
(16)
38
20
(13)
35
18
(11)
33
17
(10)
30
16
(8)
26
14
(6)
24
12
(5)
21
11
(4)
60
(21)
$317

Sensitivity Analysis
Overhead

4- 13

Ove rhe a d
Sa vings

Ye a r
0
1
2
3
4
5
6
7
8
9
10
11
Tota l

Afte r
Ta x
CF

$90
90
90
90
90
90

PV of
Ca sh Flow
a t 10%

$43
43
43
43
43
43

0
0
0
0
$27
24
22
20
18
17
$129

Sensitivity Analysis
Erosion

4- 14

Contribution
Loss from
Erosion

Year
0
1
2
3
4
5
6
7
8
9
10
11
Total

$180
200
210
220
230
230
240
240
250
250

After tax
Cash Flow
($86)
($96)
($101)
($106)
($110)
($110)
($115)
($115)
($120)
($120)

PV of
Cash Flow
at 10%
(79)
(79)
(76)
(72)
(69)
(62)
(59)
(54)
(51)
(46)
($647)

4- 15

NPV Sensitivity Analysis

JELLO FACILITIES

OVERHEAD
yes

yes

EROSION

(109)
no
yes

yes

(109)

no

208
no
yes

538
yes

no

(109)

538

20
208
337
538

538
no
yes

855

667
855

no

no

984