Incremental Cash Flows

Incremental cash flows are those that are relevant to a specific project, and thus should be included in the calculation of a project’s NPV. These incremental cash flows are what management should use in its decision to accept or reject the project. General Foods (“GFC” or “The Company”) incurred test market expenses in an effort to determine whether Super could be competitive in its target market. I believe that these expenses should not be included in the incremental cash flow analysis of Super, as they would fall under the definition of sunk costs – ones that have previously been incurred and should have no bearing on a prospective analysis of the project.

The case notes that Jell-O sales erosion is likely to occur. I believe the effect of this should be included in the incremental cash flow analysis as well, as it is a direct consequence of accepting the Super project. However, I think that these costs need to be tax-effected at the 52% rate, since the company would only receive in cash after taxes 48% of the gross margin dollars if the erosion were to not occur. Further, and perhaps more notably, capital used on the Super project comes out of GFC’s overall capital expenditure budget, and thus the expansion or modification of Jell-O is also an opportunity cost of accepting the Super project as well. I feel this erosion is, then, more likely to occur if GFC does not put additional capital into the Jell-O product, which furthers the need for this erosion to be included in the incremental cash flow analysis.

With regards to overhead expenses and the charge allocation for the agglomerator usage, I think only the costs directly attributable to the project should be considered in the incremental cash flow analysis. As an accountant by trade, I was originally drawn to the facilities-used basis, as I feel that’s the most “accounting-centric” approach that makes sense – Super would use half the agglomerator, and two-thirds of Jell-O’s building, thus it should be charged pro-rata to the project. However, this is not useful for capital budgeting purposes, as it merely moves money through cost allocation and doesn’t accurately represent a Company’s required cash forecasting. In Appendix A, I calculated that the overhead expense to be added to the final six years of the project for CF purposes is $90,000 annually – which I have added to my project cash flow chart in Exhibit 6. This was calculated based on the delta between the facilities-used basis and the fully allocated basis, and begins in year 6 when the variable costs become fixed project costs. The usage of half the Jell-O agglomerator and two-thirds of the building charge would be included in the facilities-used basis, but not in the incremental analysis in that exhibit. If the dessert market does truly grow as planned, and Super does not just directly erode Jell-O’s