Super Project Summary
Super was anticipated to capture 10% going forward, with 80% of that growth in market share and/or powdered mixes versus other types of deserts, while 20% would come from eroding Jell-O sales. Production was anticipated to Increase to 1. MM units from the projected 1 . MM given two-shift, five-day workweek. This still represented considerable excess capacity. General Foods Accounting and Financial Manual identified four categories of capital investment proposals: (1) safety and convenience; (2) quality; (3) increase profit; and (4) other.
Super was targeted at the third category. Estimates for payback and return were required for any project requiring more than $50,000 In capital and expense before taxes. In calculating the repayment period. Only incremental Income and expenses related to the project were used. The desire was to show continuous growth. However, the nature of the food industry is cyclical. Given the size and breadth of General Foods, they desired to introduce new products without showing a loss when doing so. The target was to expand faster than GNP.
Costs related to the initial test market were included as “Other” in the first period so hat the project paid for these costs rather than considering them sunk. “Adjustments” indicated represented the erosion of the Jell-O market. No indication of costs for use of the existing agglomerate is indicated in the financial data since it cannot be represented Incrementally. Pro rata allocation of the agglomerate would Increase the Initial Investment from $200,000 to $672,000. The balancing evaluation for the project indicates the $200,000 in capital would be fully recovered in 6. 83 years.
This technique would result in a project paid back in 7 years with ROOF of 63%. This method represents General Foods policy for projects at the time of this writing, but does not apply to this project since existing facilities are extensively used and they are adaptable to future uses as well. As a result, the Super project should be charged with the ‘opportunity cost’ of agglomerating capacity, building space, etc. It must be noted that space used by Super may be taking up space or capacity that could be used by other projects in the future. Thus, there are real costs to its production that will not be revealed by using this method. Facilities-Used Basis – Due to the project’s use of half the agglomerate and two- thirds of an existing building, Super would be charged a pro rata share of those facilities ($435,000). Overhead costs would be subtracted from incremental revenue as well. Resulting ROOF would be 34%. With this type of evaluation, the project is put on a more common ground with other projects for relative evaluation. * Fully Allocated Basis – This evaluation method adds considerations for overhead expenses and overhead capital by recognizing increased costs and investment base over the “Facilities-Used Basis” shown above.
In this example the increases were made midway through the ten year project span since most changes would likely be made early in the project life cycle. Super is charged with an overhead burden proportional to the anticipated level of business activity. All of the additional impact caused by the project, including additional headquarters overhead and an anticipated 50% increase in sales force to meet the needs of the more complex easiness, are not related directly to the manufacturing of products but are key to business activity and the results of all actions taken.
Resulting ROOF is anticipated to be 25%. Using the given information, the Incremental Basis provided he believed that it was not a realistic representation of the anticipated results of the project. Taking all of the complexity of the business into account, he felt that the Fully Allocated Basis method was much more realistic and provided the best long range projections and financial picture.