Super Project Final

Valuation of the Super Project
Group Members:
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Gordon Schwabe
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11/24/16
AGENDA
1.
2.
3.
4.
5.
6.
7.
Case summary
Problem statement
Clarifying problems & solutions
Comments on the 3 evaluation approaches
Recommendations on evaluation
Cash flow statement
Conclusion

Fachhochschule Brandenburg University of Applied Sciences Fachbereich Wirtschaft
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Case Summary
General Foods is a large corporation organized by productl

Super is a proposed new instant desert, based on a flavored, watersoluble, agglomerated powder.
General Foods has numerous projects with a strict criteria to judge
their value for the company
There are basically three types of capital investment proposals at
General Foods:
Safety
Quality
Increased profit

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Problem Statement
3 methods, each passes with advantages and disadvantages

Incremental / Facilities used / Fully allocated
Memos indicate that General Foods finance personnel are
questioning the same criterias ability to accurately reflect the value
of the Super project
No precise estimation of company value, because of the high variance
in the evaluation methods
INCREMENTAL
FACILITIES USED
FULLY ALLOCATED
ROFE = 63%
ROFE = 34%
ROFE = 25%

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Problem Statement What is ROFE?

GF uses Return On Funds Employed (ROFE) to evaluate the viability of
capital projects, and to weigh one project against another to determine
prioritization.
ROFE = EBIT / Capital Invested (book value)
Ratio of EARNINGS created from the book value of capital invested
Using EBIT, does not capture net operating cash flow
Uses book value (depreciated value) of capital investments
If capital assets are depreciated, they appear to create a cash flow
Depreciation is an accounting expense not a cash flow
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, it has flaws.

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Problem Statement - How we should deal with
Test-market expenses
Erosion of Jell-O contribution margin
Allocation of charges for the use of excess agglomerator capacity
Overhead expenses

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Test-market expenses
Should only be taken into account if they can be attributed to the

particular project
In the Super case these expenses had been made before the Super
project had started
Will not be taken into account in the FCF

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Super will displace part of Jell-Os market share

Erosion of Jell-O contribution margin should be taken into
account

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Allocation of charges for the use of excess agglomerator

capacity
Not counted in the FCF of the Super Project

Charges represent opportunity costs for the Jell-O devision or future
projects
Take costs into account on a corporate level

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Should be taken into account if they can be attributed to the
particular project
General Foods Corp. already counted theses costs in the CF of
Jell-O

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Overhead Expenses
Should be taken into account if these expenses can be attributed to
Super
Overhead expenses for the Super Project are not clearly defined
Overhead expenses will be taken into account in the FCF

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Incremental Basis
This evaluation approach uses only directly identified cash flows
Only incremental approaches has been taken into account
Jell-O facilities and production capacity are not relevant for Super
because they have already been counted in the CF.
This execution of Incremental Basis is flawed because it:

Includes sunk costs (the marketing study)
Fails to account for relevant increasing overhead costs.
Fails to take into account income-tax-reducing depreciation.
Utilizes ROFE. Again, ROFE is no good for capital budgeting

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Facilities-Used Basis
Super will use 1/2 of Jell-Os agglomerator
Super will use 2/3 of Jell-Os building
Super pro-rata share is $453 K
Charges Super with the facility overhead ($28k p/y).
This approach
In the capital budgeting process only incremental cash flows are
taken into account.
Only shifts costs ($453K in facilities) to Super, which is an
accounting maneuver and does not effect the cashflow
Its a net zero method, it just moves costs
Useful for accounting, not for capital budgeting

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Fully Allocated Basis
Facilities-Used Basis + overhead expenses

Overhead expenses:
Selling, general and administrative costs
This approach
Gives the most inclusive analysis of existing cash flow
Adds overhead costs correctly

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Evaluation of the Super Project
GF can do this by:

1. Taking into account incremental cash flows
2. Modifying their income statement to deduct depreciation before
calculating tax
3. Ignore sunk costs (marketing test, Jell-O facilities, etc.)
4. Remove depreciation from capital assets for purposes of evaluation
5. Accept overhead from growth/doubling powdered dessert line

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Recommendations evaluation of the Super Project
$200k for high speed filling/packaging equipment, finish packing room

$360k market test irrelevant
Opportunity cost for Jell-Os facilities and equipment
Not relevant same opportunity for any project using this
building
From corporate POV, hard to sell to move in some business to
utilize temporarily excess Jell-O facilities, low feasibility
Capital depreciation non-cash expense irrelevant
Capital depreciation expense tax deduction relevant to operating
cash flow
Shift $453k pro-rata share of Jell-O facilities and agglomerator
Incremental test irrelevant

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Recommendations Evaluation of the Super Project
$28k avg. yearly depreciation of Jell-O facilities Incremental test

irrelevant
$19k business expansion capital for distribution system Incremental
test relevant
Expansion capital depreciation expense tax deduction relevant to
operating cash flow
$90k additional yearly overhead expense for business expansion
Incremental test relevant

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Free Cash Flow

600.00
400.00
200.00
Amount
0.00
1
10
-200.00
-400.00
-600.00
-800.00

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11
Free Cash Flow
INCREMENTAL
FACILITIES USED
Net Sales
Net
Earnings
Discount
rate
4,66%
7,69%
NPV
447,59
248,64
IRR
13%
Net Sales
13%
Net
Earnings
Discount
rate
4,66%
7,69%
NPV
280,38
67,31
IRR
9%
Net Sales
9%
Net
Earnings
4,66%
7,69%
-102,79
-286,13
FULLY ALLOCATEDDiscount
rate
NPV
IRR
3%
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3%
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Conclusion
An expansion or broadening of market capture by appealing to

somewhat parallel consumer needs
Take advantage of short term availability of Jell-O facilities - in the
long term it is not a better project just because it fits a facility that is
temporarily unused
Main Points:
NPV is in 2 approaches positive
IRR is in 2 approaches higher than discount rate (decision premise)
Payback after the 6th year (shorter than normal payback period)
Do the investment

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Fachbereich
Wirtschaft
Thank you for your attention
Appendix Incremental CF

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Appendix Facility Used CF

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Appendix Fully Allocated CF

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Appendix Excel File
Excel File

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Appendix - Depreciation

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Appendix Opportunity costs

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Appendix Erosion of Jell-O

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Appendix Tax rate

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Super Project Final

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Valuation of the Super Project

Valuation of the Super Project

General Foods is a large corporation organized by productl

Valuation of the Super Project

3 methods, each passes with advantages and disadvantages

Valuation of the Super Project

Problem Statement What is ROFE?

Valuation of the Super Project

Problem Statement - How we should deal with

Valuation of the Super Project

Should only be taken into account if they can be attributed to the

Valuation of the Super Project

Erosion of Jell-O contribution margin

Super will displace part of Jell-Os market share

Valuation of the Super Project

Allocation of charges for the use of excess agglomerator

Not counted in the FCF of the Super Project

Valuation of the Super Project

Erosion of Jell-O contribution margin

Valuation of the Super Project

Valuation of the Super Project

This execution of Incremental Basis is flawed because it:

Valuation of the Super Project

Valuation of the Super Project

Fully Allocated Basis

Facilities-Used Basis + overhead expenses

Valuation of the Super Project

Evaluation of the Super Project

GF can do this by:

Valuation of the Super Project

Recommendations evaluation of the Super Project

$200k for high speed filling/packaging equipment, finish packing room

Valuation of the Super Project

Recommendations Evaluation of the Super Project

$28k avg. yearly depreciation of Jell-O facilities Incremental test

Valuation of the Super Project

Free Cash Flow

Valuation of the Super Project

Free Cash Flow

An expansion or broadening of market capture by appealing to

Valuation of the Super Project

Thank you for your attention

Valuation of the Super Project

Appendix Facility Used CF

Valuation of the Super Project

Appendix Fully Allocated CF

Valuation of the Super Project

Appendix Excel File

Valuation of the Super Project

Valuation of the Super Project

Appendix Opportunity costs

Valuation of the Super Project

Appendix Erosion of Jell-O

Valuation of the Super Project

Appendix Tax rate

Valuation of the Super Project

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