Super Project

Background

General Foods was organized along product lines in the United States, with foreign operations under a separate division. Super was a new instant dessert, based on a flavoured, water-soluble, powder. Although four flavours would be offered, it was a estimated that chocolate would account for 80% of total sales. The $200,000 capital investment project request for Super involved $80,000 for building modifications and $120,000 for machinery and equipment. No cost for the key machine was included in the project.

The market:

On the basis of test market experience, General foods expected Super to capture a 10% share of the total dessert market. Eighty percent of this expected Super volume would come from growth in total market share or growth in the powders segment, and 20% would come from erosion of Jell-O sales.

Production Facilities:

Filling and packing equipment to be purchased had a capacity of 1.9 million.

Capital Budgeting Procedure:

Four categories of capital investment project proposals

• Safety and convenience

• Quality

• Increase profit

• Other

Super fell into the third category, as a profit increasing project. $50,000 or more of new capital funds and expense before taxes. In calculating the repayment period, only incremental income and expenses related to the project were used. ROFE was calculated by dividing 10-year average profit before taxes by the 10-year average funds employed.

Capital Budgeting Atmosphere:

Our problem is to find enough good solid projects to employ capital at an attractive return on investment.

The key to our capital budgeting is to integrate the plans of our eight divisions into a balanced company plan which meets our overall growth objectives.

Documentation for the Super Project:

Multiplying the volume of erosion times a variable profit contribution.

Problematic

There are several problems concerning to the management that should be solved before making a decision on the project. The main problem, as mentioned in the text, is that management finds it difficult to identify good solid projects to employ their capital at an attractive return on investment. Therefore, they are evaluating the chance of investing on the Super Project by making an analysis, which will tell them the value creation or destruction of this initiative. Among other things, the management is wondering if the test marketing expenses should be included in the analysis and if the project should absorb a charge for overhead expenses. They are also deciding whether to charge the project with the lost contribution margin on Jell-O if it goes forward or if it must be charged for the use of the excess agglomerator and building capacity. The management also needs to know what are the relevant cash flows to use in the Super Project and their net present value. It is also necessary to calculate the IRR in order to evaluate the profitability of the project. With all this calculus, the management is trying to find a solution that will promote or reject their motion.

Solution

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