The Super Project

1
The Super Project

• Cash Flow Estimation for Capital Budgeting

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

3
Test Market Expense
Product Design
Market Testing
Manufacturing Investment
Working Capital
RD
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?

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?

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?

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 r10

8
Cash Flow from Operations
Depreciation for Jell-O facilities Sum-of-year
digits 40/15 year lives 133/320
9
Cash Flows for Super
Investment tax credit of 8 in year 0 Tax shield
on write-off of equip. in yr 11
10
DCF Calculation
NPV 538 accept
11
NPV Profile of Project
IRR 18.5
12
Sensitivity Analysis Use of Jell-O Facilities
13
Sensitivity AnalysisOverhead
14
Sensitivity Analysis Erosion
15
NPV Sensitivity Analysis
OVERHEAD
JELLO FACILITIES
yes
(109)
EROSION
yes
(109)
20
no
yes
yes
208
(109)
208
no
337
538
no
yes
538
yes
538
538
no
667
no
yes
855
855
no
984
no