The Super Project
The Super Project
Introduction
General Foods (GF) expects Super, a new powdered dessert, to capture 10% share of the total dessert market (2% coming from the erosion of Jell-O sales). The company’s Financial Analyst has issued a memo comparing three alternative techniques for project evaluations, illustrating the problems and limitations inherent in using ROFE (return on funds employed) and payback as evaluation methods. The disparate ROFE results obtained with these methods are due to differences in the allocation of excess capacity from Jell-O equipment and overhead costs.
Problem Statement: How should GF allocate excess capacity and overhead costs in their evaluations of capital investments for profit increasing projects?
Other Issues: - Whether or not to go ahead with the Super project * How is the Super project meeting the shareholders-enhancing value policy of the company
Analysis
Jell-O Excess Capacity: By using this excess capacity to produce Super, the firm forgoes opportunities in using this equipment for “known future alternative uses” (p.443). Had this excess capacity not been available, the company would have needed to build/acquire it in order to proceed with the Super project. Similarly, had the firm not engaged this excess capacity in the production of Super, it is likely that it would have been put to another productive use (probably in the production of Jell-O, a product line whose production levels have recently increased substantially). For these reasons, the proportional use of the costs associated with the Jell-O building (66.6%) and agglomerator (50%) must be added as Opportunity Costs; this also necessitates certain assumptions regarding CCA tax shields and depreciation (see Appendix B).
Overhead Cost Allocation: The ‘Stand Alone’ principle requires that a project “pay” if it is using resources from other departments. However, since overhead spending decisions at GF are “made separately from decisions to
Introduction
General Foods (GF) expects Super, a new powdered dessert, to capture 10% share of the total dessert market (2% coming from the erosion of Jell-O sales). The company’s Financial Analyst has issued a memo comparing three alternative techniques for project evaluations, illustrating the problems and limitations inherent in using ROFE (return on funds employed) and payback as evaluation methods. The disparate ROFE results obtained with these methods are due to differences in the allocation of excess capacity from Jell-O equipment and overhead costs.
Problem Statement: How should GF allocate excess capacity and overhead costs in their evaluations of capital investments for profit increasing projects?
Other Issues: - Whether or not to go ahead with the Super project * How is the Super project meeting the shareholders-enhancing value policy of the company
Analysis
Jell-O Excess Capacity: By using this excess capacity to produce Super, the firm forgoes opportunities in using this equipment for “known future alternative uses” (p.443). Had this excess capacity not been available, the company would have needed to build/acquire it in order to proceed with the Super project. Similarly, had the firm not engaged this excess capacity in the production of Super, it is likely that it would have been put to another productive use (probably in the production of Jell-O, a product line whose production levels have recently increased substantially). For these reasons, the proportional use of the costs associated with the Jell-O building (66.6%) and agglomerator (50%) must be added as Opportunity Costs; this also necessitates certain assumptions regarding CCA tax shields and depreciation (see Appendix B).
Overhead Cost Allocation: The ‘Stand Alone’ principle requires that a project “pay” if it is using resources from other departments. However, since overhead spending decisions at GF are “made separately from decisions to