The Super Project Essay Example

The Super Project Essay Example The Super Project Essay The Super Project Essay 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 agglomerate (50%) must be added as Opportunity Costs; this also necessitates certain assumptions regarding CA tax shields and depreciation (see Appendix 8). Overhead Cost Allocation: The Stand Alone principle requires that a reject par If It is using resources from other departments. However, since overhead spending decisions at SGF are made separately from decisions to Increase volume (p. 444), projects should be evaluated on an Incremental basis. Since overhead cash flows (utilities, etc. ) are the same whether or not the project is accepted, charging overhead to the project would be inappropriate in this case. ROOF: ROOF at SGF is calculated by dividing the 10-year average profit before taxes by 10-year average funds employed. In essence, SGF Is using the Average Accounting Return (EAR). There are 3 major problems with this approach: first, the method uses accounting numbers rather than real cash flows; second, because It Is an average, the timing of cash flows (I. E. When inflows/outflows occur) is not taken into account; third, the 40% ROOF is chosen somewhat arbitrarily. The EAR method may entice managers to only choose projects that are profitable in the near term, rather than evaluating them based on their long-term value and contribution. The first period only depreciates by 5% while the next nine will depreciate by 10%. After all the depreciation has occurred there will just be the salvage value remaining for the capital asset. With depreciation being paid each year there is a tax shield created. A tax shield is a deduction in income taxes that result from taking an allowable deduction from taxable income. To find out how much the tax shield the Super Project has, just take the amount of depreciation for that period and multiple it by the tax rate (52%). The tax rate used was the average tax rate over the past 10 years. Cost of Debt and cost of equity help get different rates that are an important factor in figuring out the weighted average cost of capital (WACC). Cost of debt gives the interest rate General Foods would pay for all the current debts. While the cost of equity is the minimum rate of return that they must offer shareholders to keep them investing in their company. The Super Project has cost of debt of 1. 57% and cost of equity of 13%. This helps figure out the WACC which is the rate we expect to pay on average to all security holders to finance our assets. The WACC for the super project is 11. 77% which is less than the 13% rate of return that the shareholders are looking for. This tells us that the Super Project might not be the best idea. NPV is still the best measure for capital budgeting so we went ahead and did the calculations for it. To figure out the net present value we have to first figure out the cash flow. In 1968 we get earnings before income taxes of $283. This is the $643 total investment minus the $360 cost for test markets that we see as a sunk cost and are not including it as part of the Super Project. The cash flow generates positive revenue for the Super Project but we still have to factor in that the Super Project is eroding 20% of Jell-O causing their revenues to decrease along with their cash flow. After cash flow is figured out we are finally able to see what the NPV is. When calculating NPV you have to get the sum of discounted cash flows and add it to the initial investment. For the Super Project we get $298. 4 discounted cash flow + (653) fixed investment = (354. 6) NPV. With the NPV being a negative number, we know to reject the super project.