Case highlights the issues regarding the interpretation and application of estimating cash flows on incremental basis for measuring value of capital investment proposals.
In 1967, General Foods was evaluating a capital investment proposal for a new instant powdered dessert called SUPER. A recent market survey indicated that powdered dessert as a growing segment within the dessert market and SUPER was expected to capture 10% of the total dessert market. Clearly an investment decision in SUPER was going to increase the profit for General Foods.
Financial Evaluation of the SUPER project was completed showing a payback period of 6.9 yrs and Return on Funds Employed of 63%. These figures were well above the benchmark figures of General Foods justifying the investment in the profit making SUPER project.
An initial investment of $200,000 was proposed for the project with $120,000 for new packaging machinery and $80,000 modification to existing building. The spare existing facility where JELL-O (another product of General Foods) was manufactured would be used for SUPER. The Financial evaluation of the project was challenge by the Finance Manager of the company Mr. Crosby Sanberg. He argued that the use of spare capacity of JELL-O should be considered as a initial investment cost on the project. Also an estimated overhead cost should be reflected in the evaluation of the project. His analysis showed that with both these factors included in the evaluation, the return on funds employed drops down to 25%, which does not justify an investment in a profit making project.
The present analysis on the case will partially agree with Mr Sanberg's argument and will also modify the financial evaluation done for the project. For evaluating a project relevant cash flo ...