The Super Project

Summary of Facts

General Foods Corporation is a food manufacturing company known for their popular brands such as Kool-Aid, Post, and Jell-O. The company is considering introducing a new instant dessert product called Super. Taking on the Super project would require an initial capital investment of $200,000. The investment would be used for building modifications and equipment, but no key machinery would need to be purchased. The agglomerating equipment used by General Foods to produce Jell-O is not operating at full capacity so the excess capacity could be used to manufacture the Super. After market testing, General Foods determined that Super would most likely capture 10% of the powdered dessert market. Of this market share, 80% would come from growth and the other 20% would be due to the erosion of the Jell-O market. Management at General Foods is debating the relevant cash flows for the Super Project, so they came up with three methods for allocating the cash flows: incremental, facilities used, and fully allocated. Each method has a different return of funds employed (ROFE) of 63%, 34%, and 25% respectively. Now management must make a decision as to which cash flows are relevant in order to give the most accurate representation of the Super project's profitability.

Issues

The problem facing General Foods Corporation is determining whether manufacturing Super is a worthwhile and profitable project. In order to evaluate the profitability of the Super Project, General Foods must use capital budgeting techniques. They need to decide how to allocate test market expenses, start up costs, any additional overhead expenses, the erosion of the Jell-O market share, and the use of the full potential of the agglomerator. It is imperative to analyze these cash flows to determine which are relevant when forecasting the overall profitability potential of the investment project. In addition, calculations such as net present value, internal rate of return, payback period, and accounting rate of return should be considered.

General Foods has written criteria that outlines the characteristics that projects must have in order to be considered. The Super project is classified as a new product designed to provide facilities to manufacture and distribute a new product. Because these investments have a higher risk, an acceptable project must show a high potential return, no less than 40%. A cash flow analysis is necessary in order to ascertain the profit potential so the issue is to make sure the appropriate cash flows are included. Including an irrelevant cash flow or excluding a relevant one could greatly affect the decision. General Foods must also determine if the benefits of the project will outweigh the risks and whether the project is attractive in terms of competition. If General Foods does not take on the project, a competitor could easily move into the market with