Analysis Case

1. What are the relevant cash flows for General Foods to use in evaluating the Super Project? In particular, how management deal with issues such as :

Relevant cost should be identified and included in the calculation. Relevant costs are generally defined as such costs which would be changed due to the adopting the project and occurred by making the decisions.

a) Test-market expense?

Test-market expense (360K from exhibit 3) should be excluded because it is past expenses already incurred. Since sunk cost such as test-market expenses had been paid regardless of the decision whether or not the project is undertaken, it is irrelevant and could be excluded from the incremental analysis.

b) Overhead expense (The estimate from exhibit 3 is $54K per year)?

Overhead expense should be excluded in our analysis. In general, increased overhead costs resulted from conducting a new project should be included in the calculation of incremental earnings. In other words, overhead costs which have not been changed should not be included. In this case, no more cost need for its project since existing capacity of a Jell-O agglomerator would be used in the manufacture of Super.

c) Erosion of Jell-O contribution margin?

We should consider cost from the erosion of Jell-O contribution margin. It is a kind of opportunity cost because General Foods anticipated that 80% of 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. That means that if the company would not take the project and it keep producing the current product, Jell-O then it could gain more additional profit than it would take. We can also see this cost in the aspect of cannibalization. Cannibalization usually occurs when the sales of new product affect the sales of current product negatively. In this case, the erosion of the Jell-O's contribution margin could be said to occur due to the launch of Super.

d) Allocation charges for excess capacity?

We should not consider allocation charges for excess capacity in this case when calculating the cash flow. Usually the charges for excess capacity is included in the cash flow, however in this case, we cannot relate the equipment revamping to the production of Super and the company has no choice but to pick up the facility even though the company knows that it will incur the extra capacity because there is no economic alternative.

2. How attractive is the Super Project in strategic and competitive terms? What potential risks and benefits does General Foods incur by either accepting or rejecting the project?

As a result of NPV, the project has positive value as below exhibit. Therefore we can conclude that the project should be accepted. By accepting the project