Advanced Financial Management – Professor Dahiya
We feel that General Foods Corporation ought to go ahead with the Super Project. While we feel the incremental costs approach lacks a certain degree of sufficiency in taking into account all overhead, we believe the $453,000 cost of using the existing Jell-O facilities would have already been accounted for on the Jell-O balance sheet and thus is a non-factor in determining the profitability of the Super Project. Simply adding the cost of erosion to Jell-O’s sales ought to be sufficient in rectifying the costs of switching the machine’s function. Before we could begin to calculate the net present values of the base case and the fully allocated costs method it was necessary to determine an appropriate discount rate. In order to do this we calculated the weighted average cost of capital by determining that General Foods Corporation return on equity was equal to 15.4% and by estimating its cost of debt to be approximately 6% based on industry norms. Given the firm’s current total equity of $611m and its total debt of $318m and a tax rate of 52% we found General Foods Corp. WACC to be 11.3%. In determining the base case scenario, we simply took into account the capital expenditure on new building and equipment costs, the initial investment in net working capital as well as its subsequent yearly fluctuations, and the appropriate operational costs as detailed in Exhibit 1. This left us with a net present value of $760,000. However this did not include the test market expense, the erosion expense, the existing facilities expense, nor the overhead cost allocations. When we added the cost of erosion, which we feel is the most accurate indicator of the project’s net profitability, we found the NPV to be equal to $150,000. We felt this was the best method because the capital expenditure on the existing equipment had already been taken into account upon its original purchase. Additionally, attempting to...
Please join StudyMode to read the full document