The Super Project

General Foods Corporation is a food company involved in the business of producing

ingredients for the dessert market. They currently have three categories of
products powders, mixes and ice creams. The powder division produces two
products JellO and Tasty. They are looking to introduce a new powder Super.
Crosby Sanberg, manager financial analyst, is tasked with the job of analyzing
the profitability of the new project and his opinion is that the incremental analysis
doesnt always work for the profitability of the project.
Super falls under a significant and growing segment, potentially increasing dessert
market share by 10% - 80% from new market and 20% from erosion of Jell-O
sales. The project will require Capital Expense of $200,000 ($80K for building
modification and $120K for packaging machinery), $15,000 as startup cost, and
test market expense of $360K, which has already incurred prior to fund
allocation. Super is discussing whether it will also incur an opportunity cost
($453K) by utilizing some of the existing facilities from Jell-O product building and
agglomerator. Finally, theres discussion about allocating some overhead costs,
starting in year 5 after initiation. These overhead costs are categorized as Capital
($40K) and Expenses on a per unit basis. There are certain pre-planned
overhead costs (Alternative III - Discussion) planned for year 1968, and if
approved, Super will benefits from this investment.
Based on positive NPV, IRR much higher than WACC, and 9 year payback time
period, General Foods should launch the new product line. In order to calculate the
key metrics, following assumptions were made.
Items NOT included as part of Free Cash Flow calculations:

Test Market Expenses: are sunk costs and cannot be recovered, regardless of
approval of Super.
Opportunity Cost: for building and agglomerator is not considered
incremental. Moreover, they are not generating any rental income that will
potentially be lost due to Super.
Overhead Capital: ($40K) for distribution systems, is based on the theory
that a number of individual decisions towards further expansion will result in
more fixed costs and facilities in Year 5. Some of this could be due to
introduction of new product lines, and some due to expansion in existing
product lines. Since this capital expense isnt incremental to Super project
alone, they should be considered as part of Free Cash Flow calculations for
future projects alone whether for new product or for expansion of existing
product lines.

Pre-planned expenses: The overhead costs are pre-planned and are expected
regardless of approval of Super. They will result in additional capacity, which
can be used for subsequent projects (if Super is not approved)

Following Costs should be taken into consideration, while calculating Free Cash
Flow.

Overhead Expense: in year 5 (Alternative III Method) will be incremental

only because of Super product. This SG&A expense wont be realized if the
company decides to kill this project.
Jell-O Erosion: Since 20% of sales of Super were to come from erosion of the
sales of an existing product, those erosions should be taken as a cost for the
project. If Super is launched, this revenue will be lost incremental cost.

Considering the costs of the project, we can estimate the net operating profit of
the project (Exhibit 1). Combining the net operating profits of the project with the
various costs required at different stages along with the correct classification of
expenses, we can estimate the free cash flows of the project. Based on the
estimates, an estimated 10 year project life, no salvage value at maturity and a
10% cost of capital, we can calculate the different measures of profitability of
project:
1. NPV of the project: $891K
2. IRR of the project: 23.3%
3. Payback period of the project: 9 years
Based on the history, the firm has paid between 8.4% and 10.1% dividends on the
common shares. Since this project shows a return rate of over 20% (beats hurdle
rate by all 3 measures at 10% cost of capital), this project is more profitable than
the usual business of General Foods Corporation.
The past projects at General Foods Corporation have resulted in unexpected
increases in costs. The risks involved in the project are:

Much of the profitability of the project lies in deploying under-utilized resources.

Unexpected expansion in existing products could lead to competition for
resources which will alter the company profitability
A forecasting error in sales can alter the return rate on the project
Over the long run, variable costs may increase as a result of volume increase
and this may result in a lower rate of return than what is being displayed, so
Super may not be a long term profit generator.
The incremental investment in the packaging and machinery is specific to Super
and may pose a risk if they cannot be used to generate other products

Revenue growth may be limited or stagnant if Super cannibalizes other products

as in that case, the revenue will shift from the other products but not increase
overall.

Considering the risks, if the company doesnt have an alternate profitable project
in the pipeline to utilize the existing resources, the Super project is a good choice
to increase the returns for the shareholders equity. Moreover, Super project is a
good strategic fit for General Foods Dessert product line. The case presents
evidence that powdered desserts constituted a significant and growing segment,
so any project that strengths leadership in existing market segment should be
worth investing.