Super Project

Valuation of the Super Project

Group Members:

XXX XXXXX

XXX XXXXX

Gordon Schwabe

XXX XXXXX 10.04.2023

Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page10.04.2023

AGENDA

1. Case summary

2. Problem statement

3. Clarifying problems & solutions

4. Comments on the 3 evaluation approaches

5. Recommendations on evaluation

6. Cash flow statement

7. Conclusion


2


Case Summary

• General Foods is a large corporation organized by productl

• Super is a proposed new instant desert, based on a “flavored, water-soluble, 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


3


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 criteria’s 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

• ROFE = 63%

FACILITIES USED

• ROFE = 34%

FULLY ALLOCATED

• ROFE = 25%

4

Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page10.04.2023Valuation of the Super Project

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.

5


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

6


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

7


Erosion of Jell-O contribution margin

• Super will displace part of Jell-O´s market share

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

8


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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Erosion of Jell-O contribution margin

• 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

10


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

11


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-O’s agglomerator

• Super will use 2/3 of Jell-O’s 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

• It’s 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

15


Recommendations evaluation of the Super Project

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

• $360k market test – irrelevant

• Opportunity cost for Jell-O’s 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

16


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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1 2 3 4 5 6 7 8 9 10 11

FCF Incremental

-200 -518.11022446647

-5.45598229167295

5.16990578633012

86.1474979420782

246.099709127303

221.056489399153

233.411166603169

245.889556739094

263.028135302359

303.209933593774

FCF Facility used

-453 -518.11022446647

6.42107431331856

16.3871259132665

96.7048815909596

255.99725629813

229.634363613869

241.32920433983

253.1477579977

269.626500082909

345.458273212964

FCF Fully Allocated

-672 -518.11022446647

6.42107431331856

16.3871259132665

96.7048815909596

212.942144064894

186.579251380634

198.274092106595

210.092645764465

226.571387849674

333.833392909991

-700.00

-500.00

-300.00

-100.00

100.00

300.00

500.00

Am

ou

nt

Free Cash Flow

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Free Cash Flow

Net Sales Net Earnings

Discount rate

4,66% 7,69%

NPV 447,59 248,64

IRR 13% 13%

19

Net Sales Net Earnings

Discount rate

4,66% 7,69%

NPV 280,38 67,31

IRR 9% 9%Net Sales Net

Earnings

Discount rate

4,66% 7,69%

NPV -102,79 -286,13

IRR 3% 3%

INCREMENTAL

FACILITIES USED

FULLY ALLOCATED


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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