Super Project

On its face, Super seems like a simple enough project. Spend $200,000 in capital, receive a 62 percent return on investment. Capitalize on existing facilities and processes. But, like so many Jell-O desserts, this product has several layers. The project proposal fails to take many factors into account that ultimately affect the actual value.

The expected free cash flows for the Super Project should be analyzed by using the anticipated profit before taxes (line 35 on the Financial Evaluation Form). This profit includes the cost of the test market, the erosions to the Jell-O line and the cost of goods sold. This calculation does not take into account any interest expenses that might be incurred by financing this project, but it is the column used by the proposal’s author to forecast profit. By using this calculation and an interest rate of 10 percent as the basis for free cash flow, the Net Present Value of the project would be approximately $880,000.

By using the same assumptions of cash flow, the Internal Rate of Return would be approximately 27 percent, which is much better than the weighted average cost of capital, which is at 10 percent. According to this calculation, Super would be a wise investment for General Foods. But these figures do not take into account some hidden costs.

First, there is the $360,000 expense of the product packaging test. While one might argue that this is a routine function of Research and Development, this test was conducted for the sole purpose of furthering the Super Project proposal and should thus be considered one of the costs of the project. Ultimately, the decision of capitalizing or expensing this cost would be up to management, but the fact that this sunk cost is not fully recognized in the Super proposal seems a little suspect.

Second, the proposal assumes no responsibility for using 50 percent of the agglomerator and 66 percent of the building. According to Sanberg’s analysis of these facilities, if Super were to cover...