Super Project

Another struggle against paybacks and accounting rate

But the focus is on cash flows
Important reads
• Page 1: 120,000 of Machinery only included packaging machinery.
JellO machinery was taken at no cost
• Sales would come from erosion of Jell O sales
• Look at the discussions on payback and returns on Page 2..and theres
no capital rationing
• Look at Exhibits 4, 5 and 6
• Look at Appendix A
Important points
• Only incremental cash flows give a return of 63%
• Facilities used return was 34%
• Fully allocated basis return was just about 25%, just above 24% cut
off
 Case Focus
• Whether Test Market expenses should be included in analysis.
• Whether to allocate to the super project a charge for the use of
agglomerator and building capacity
• Whether to include an allocation of the overhead cost in capital
budgeting decisions
• Whether to charge the super project with the lost contribution
margin on Jell O, which might be caused by introduction of super
project.
Test Market Expenses-?
Exhibit 6 ( Line 33)
Test Market expenses were twice the capital funds
 Test Market Expenses
Sunk Costs –When to start and Where to stop

Working
Market Manufacturing
R&D Product Design Capital
Testing Investment
Investment
The trade off is if you push too much towards right to get realistic
estimates you loose control on economics

Project can have a 25% DCF ROI and still running at a loss
Allocated charge for capacity
utilization-?
 Sanbergs proposal--Allocated Charge for capacity utilisation

• Jello O sales are increasing like 40% over the past two
years….agglomerator capacity has to increase.
• Acceptance of Super Project would mean even a greater capacity
increase.
• But this is not risky investment
• Even if Super Project is discontinued, JellO can do with the excess
capacity.
•
Exclusion of Overhead Costs – Is
it right and are these costs
fixed?
Look at Exhibit 3 and calculate SGA/sales from 1958 -1967
 Sanbergs question – Allocation of Overhead
Costs
• SGA has risen from 17.9% to 27.2 %.
• We can include overheads starting from year 5.
• Look at Sanbergs estimates in Exhibit A. (211-157)
• Average Profit before taxes would fall by 54000/= if overheads would have
been included.
• SO,Annual Incremental overheads=90000= (54000/ 6)*10
• Charges for lost Contribution: Inclusion of lost sales is questionable. A
capital budgeting system that puts a heavy weight on erosion of certain
product lines is itself questionable. If the company would not competitors
surely will come into the market. Why!!! Because opportunity is there
 Test Market expenses and
erosion of Jell O is excluded
But it is charged with capacity utilization and overheads