Note: This case assumes that Jell-O would realize losses with or without the Chiffon project; however, a review of this case suggests the opposite. Actually, Jell-O would grow and the cost of the agglomerator should be included as an incremental cash flow.
In 1967, General Foods (GF) was contemplating the launch of a new product line - Chiffon. As one of the market leaders in the food business, the company was focused on increasing and protecting its current market share in the dessert category. Specifically, powdered deserts were forecasted to grow at a faster rate than other desserts. Jell-O, owned by GF, comprised 19% of the overall market; however, GF desired to launch a new product (Chiffon) in order to gain an increasing percent of the market as well as prevent new entrants.
The Chiffon Project needed careful consideration as it would cannibalize Jell-O sales, which comprised 19% of the market, and was growing. Chiffon would be successful based on market test results that GF conducted. Valuation of the Chiffon project was critical as it would determine whether or not the product line was launched.
The challenge lied in determining the appropriate methodology to use when valuing a project that would use existing PP&E. Three alternatives were presented: Incremental Basis, Facilities-Used Basis, and Fully Allocated Basis. Results Summary
A combination of the three methods was used in determining the value of the Chiffon Project. The underlying determinant was that cash flows must be both incremental and predictable to be included in the cash flow analysis.
The value of GF in 1967 without Chiffon was $1.85 Billion. The value of the Chiffon Project was calculated to be (-) $10.6 Million. As a result, the value of GF with Chiffon was calculated as the difference between the two at $1.84 Billion. Based on our results, the Chiffon project should be rejected as it had a negative NPV and brought down the value of GF.
Assumptions regarding valuations and/or incremental cash flows are discussed for both GF and the Chiffon Project below. General Food’s Initial Valuation without Chiffon
As minimal data was given, the best valuation of GF was what the market perceived the value to be. The value of GF without Chiffon was calculated by multiplying the 1967 shares outstanding by the average 1967 share price: 25,127,007 shares outstanding * $73.5 average share price = $1.85 Billion.
The average share price was used so as to not over or under inflate the value of GF at the time. Assumptions were that the market value of the stock incorporated the current state of GF and the possible churn in Jell-O sales, both without the launch of Chiffon. The churn in Jell-O mentioned considers that other powdered desert market entrants may decrease Jell-O sales. Chiffon Project Valuation
Overall, incremental cash flows were used for ten years (1968 – 1977) in every aspect of the methodology that follows. Many income statement items were given on the Chiffon Financial Evaluation Form which resulted from the market test conducted; other assumptions were added if they were considered incremental and predictable to the Chiffon Project. First, a discussion of what was included as an incremental cash flow relative to the income statement is necessary. The Income Statement can be seen in Exhibit 1. Incremental Income Statement Cash Flows
Several items that were not altered in our valuation include: Revenues, Cost of Goods Sold, Selling Expenses, Start-Up Costs, Depreciation, Incremental Erosion of Jell-O Sales, and Taxes. Goodwill Amortization and Net Interest Expense were held at zero as they are not relevant as an incremental cash flow to the Chiffon Project and are not easily predictable.
The meat of this analysis relates to the inclusion of additional Overhead and G&A Expenses. Building Overhead Expenses that were required to run the existing...