The Super Project
1) Test Market Expenses: Do not Include it is a sunk cost and cannot be recovered if the project were not to become operational. 2) Overhead cost: The Super project will initially not require incremental overhead costs. However, if and when the project grows, incremental overhead expenses will be incurred specific to the project. This has to be captured in capital budgeting to accurately assess the project. Here we assume that the project will not require considerable incremental overhead expenses till year 4 (3 year growth and market establishment). 10 Year avg. Overhead cost = 10 year avg. EBIT Facility used basis – 10 year avg. EBIT Full allocated basis = $54,000. 3) Excess Capacity: The Super project is based on the use of excess 1/3rd machine and 2/3rd building capacity of the Jell-O product. This cost has been allocated to Jell-O and thus not a const consideration for capital budgeting purposes. Also, the excess capacity and current growth rate of Jell-O does not justify the opportunity cost of excess capacity. Thus, the excess capacity should not be considered as capital investment into the Super project. 4) Erosion of Jell-O market: The Super product seems to be a ‘commodity’ product in that any Jell-O manufacturing company could potentially make this product as the machinery is the same. The low entry barrier to powder the market coupled with the growth increases the probability of a competitor to launch similar product and cause erosion of the Jell-O market. Since this market scenario seems inevitable in the near future, the addition of erosion adjustment to the Super project is not justified. 5) Depreciation add back for cash flows: The incremental analysis does not add back depreciation to cancel the effect of this non-cash transaction. We have used the depreciation method used in the case for simplicity however, realizing that a different depreciation method would create a better cash flow. 6)...
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