When Crosby Sandberg stated in the opening paragraph of the case, “What I learned about incremental analysis at the Business School doesn’t always work.” He came to the conclusion that sunk costs were relevant to capital project evaluations. In this case though, he could not have been more wrong. The sunk costs are lost once they are spent, and should definitely not be used to evaluate the Super Project.
General Foods is a large company with various divisions in both domestic and foreign operations. One account executive states that they want to grow more rapidly than the GDP, and develop projects accordingly. The Super Project will allow them to reach that ...view middle of the document...
The Test-Market Expenses are sunk costs, costs that are already incurred and cannot be recovered regardless of future events, so therefore cannot be combined in our calculation of cash flows. These expenses and cash flows may include various items as Research and Development, Product plan, Market Testing, Manufacturing Investment, and Working Capital. Since these costs may have been included with other product line we will not include them in or analysis of SP Cash Flow.
Overhead expenses- As we know from the information given General Mills will use the same building and machinery to produce the SP. There is opportunity cost of using the building and machinery since the company could have put it up for rent or sold the unused portion of the business.
The erosion of Jell-O Contribution Margin is justifiable as we consider cost profitability, expansion of market growth, company improvement, the development of new customer tastes , and company innovation. In our analysis we assume that Jell-O will suffer erosion of sales and profits from the introduction of this new product, therefore our analysis includes the erosion as a negative cash flow. Thus, this causes us to predict that other companies will follow the increasing market growth and produce similar products to capture a piece of the market share. Reviewing our calculations in the attached Exhibits I through IV P.D.C. Consultants see that erosion causes the overall NPV to decrease. However, the NPV is greater than zero in all cases, therefore P.D.C. Consultants conclude General Foods should go ahead with Super Project.
Allocation of charges for the use of excess agglomerator- which is defined as the opportunity cost. The $453M for facilities is our opportunity cost for the Super Project. In our case we depreciate it over 10 years using straight line depreciation. This excess agglomerator could be used for other products and or for the expansion of the Jell-O product.
Super Project has been reviewed under four scenarios and the results have been summarized in the following table.
Changes in net working capital and the erosion of Jell-O profitability do not impact the accounting rate of return (ARR) it stays constant at 17.2%. However, the performance of the project declines dramatically when a more complete analysis is conducted by including the ongoing investment in the changes in NWC, along with the erosion of Jell-O profitability; each measured separately and then combined.
As can be seen from the table above, under all scenarios the payback period is lengthened, net present value declines (NPV) dramatically (although the NPV remains positive) and the internal rate of return (IRR) declines sharply.
However, because the project remains positive from an NPV perspective, General Foods should undertake this project.
While the ARR, Payback, NPV and IRR all may have some level of merit in measuring the attractiveness of the Super Project, only the NPV is...