3. How should management deal with
Test-market expenses
Overhead expenses
Erosion of Jell-O contribution margin
Allocation of charges for the use of excess agglomerator capacity
4. 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 (p.2)
- Conclusion: Test-market expenses will not be taken
into account in the FCF
5. How should management deal with
Test-market expenses
Overhead expenses
Erosion of Jell-O contribution margin
Allocation of charges for the use of excess agglomerator capacity
6. Overhead Expenses
- Should be taken into account if these expenses can be
attributed to the project.
- In the Super case, overhead expenses have been
justified earlier in the Jello-O project. Also, the data
does not provide specific information on incremental
overhead expenses.
- Conclusion: Overhead expenses will not be taken into
account in the FCF
7. How should management deal with
Test-market expenses
Overhead expenses
Erosion of Jell-O contribution margin
Allocation of charges for the use of excess agglomerator capacity
8. Erosion of Jell-O
- Erosion of Jell-O contribution margin should be taken
into account. Super is expected to displace part of the
sale of Jell-O (p.2/exhibit 6)
9. How should management deal with
Test-market expenses
Overhead expenses
Erosion of Jell-O contribution margin
Allocation of charges for the use of excess agglomerator capacity
11. Excess Agglomerator Capacity
- Allocation of charges for excess capacity should be
taken into account if they can be attributed to the
particular project.
- However, General Foods Corp. Has already counted
these costs (probably in the FCF of Jell-O), so
management should not take these charges into
account for the Super FCF.
(If we wanted to evaluate the Super project, the capital expenditure of the agglomerator
would be needed and used to calculate the Super FCF.)
12. How should management deal with
Test-market expenses
Overhead expenses
Erosion of Jell-O contribution margin
Allocation of charges for the use of excess agglomerator capacity
13. Note for management
- The allocation of charges for excess capacity is not
counted in the FCF of the Super project.
- However, these charges represent opportunity costs
for the Jell-O division and/or future projects.
- We recommend HQ to take these costs into account
on a corporate level.
15. Incremental Basis / Alternative I
- This evaluation approach is the correct approach. In
the capital budgeting process only incremental cash
flows are taken into account.
- The Jell-O facilities and production capacity are not
relevant for the Super FCF because they have already
been counted.
- Therefore the incremental basis is the correct
evaluation approach.
16. Facilities-Used basis and
Fully Allocated / Alternatives II & III
- These evaluation approaches are incorrect
approaches. In the capital budgeting process only
incremental cash flows are taken into account.
- The Jell-O facilities and production capacity are not
relevant for the Super FCF because they have already
been counted.
- Therefore, it is incorrect to include Jell-O facilities and
production capacity into the Super project FCF.
18. Starting Points
- Discount rate is 11%
- FCF concerns a 10 year time scale
- Depreciation continues for a longer period
- Tax rate: 52% (exhibit 6)
- Prespecified period for payback rule; no more then 10
years.
23. Conclusion
NPV $241.47
IRR 18.33%
Payback 7 years
- NPV is positive
- IRR is higher than discount rate. IRR is usable because
negative cashflows proceed positive cashflows
- Payback is 7 years. This is shorter than the General
Foods’ prespecified payback period of 10 year.
- Team Utrecht recommends: do the investment