4- 1
The Super Project
Cash Flow Estimation for Capital
Budgeting
4- 2
Investment Criteria
 Project ranking according to
Payback period
 Accounting rate of return

 Are certain costs being ignored?
 What are the relevant project costs and cash
flows?
Test-market expenses
 Use of excess agglomerator and building capacity
 Overhead costs
 Lost contribution margin on Jell-O

4- 3
Test Market Expense
R&D
Product
Design
Market
Testing
Manufacturing
Investment
Working
Capital
4- 4
Allocated Charges for Capacity
Utilization
 Charge for excess agglomerator and building
capacity
Jell-O sales for August to September 1966
increased by 40% over previous year
 In two years you would have to increase capacity
anyway
 Super project will require earlier and even greater
increase

 Reasonable to include use as costs

Risk of investment?
4- 5
Allocated Overhead Charges
 Overhead costs are not fixed (see last 10 yrs in
Exhibit 3)

SGA/Sales: 17.9% (1958) to 27.2% (1967)
 Reasonable to include an increase from years 5 to 10
 How much?
Costs increase by $54,000/year for 10 years
 Total of $540,000
 Yearly cost from years 5-10 = $540,000/6
 $90,000

• Graduated scale?
4- 6
Charge for Lost Contribution
 Questionable charge
 Assume that Jell-O would hold volume if
Super is not introduced
 What if a competitor introduces a product like
Super?
 Erosion is inevitable?
4- 7
Assumptions and setup
 Exclude:
test market expense (sunk cost)
 erosion (inevitable)

 Include:
agglomerator and building use (opportunity cost)
 overhead costs (side effect)

 cash flow identity
cash (project) = OCF - additions to NWC - NCS
 Assume r=10%

4- 8
Cash Flow from Operations
Year
1
Net sales
$2,112
COGS
$1,100
Gross profit
1,012
Advertising expense 1,100
Increased overhead
Depreciation
46
Start-up costs
15
2
$2,304
$1,200
1,104
1,050
3
$2,496
$1,300
1,196
1,000
4
$2,688
$1,400
1,288
900
43
41
($149)
(77)
$11
6
Net Profit
Depreciation
(72)
65
Cash flow
(7)
Profit before taxes
Taxes (@52%)
38
5
$2,880
$1,500
1,380
700
90
35
6
$2,880
$1,500
1,380
700
90
33
7
$3,072
$1,600
1,472
730
90
30
8
$3,072
$1,600
1,472
730
90
26
9
$3,264
$1,700
1,564
750
90
24
10
$3,264
$1,700
1,564
750
90
21
$155
81
$350
182
$555
289
$557
290
$622
323
$626
326
$700
364
$703
366
5
61
74
58
168
54
266
50
267
46
299
42
300
37
336
34
337
30
$66
$132
$222
$316
$313
$341
$337
$370
$367
Depreciation for Jell-O facilities: Sum-of-year digits; 40/15 year lives; $133/320
4- 9
Cash Flows for Super
Year New P&E Jell-O Facilities Working Capital CF Operations Total Cash Flows
0
($200)
($453)
$8
($645)
1
($329)
(7)
(336)
2
55
66
121
3
3
132
135
4
7
222
229
5
23
316
339
6
(1)
313
312
7
(13)
341
328
8
0
337
337
9
(12)
370
358
10
0
367
367
11
31
60
267
358
Investment tax credit of $8 in year 0; Tax shield on write-off of equip. in yr 11
4- 10
DCF Calculation
Year Cash Flow Discount
0
0
1/(1.1)
=1
$645

1
0.909
$336
2
$121
0.826
3
$135
0.751
4
$229
0.683
5
$339
0.621
6
$312
0.564
7
$328
0.513
8
$337
0.467
9
$358
0.424
10
$367
0.386
11
$358
0.350
PV
$645
$305
100
101
156
211
176
168
157
152
142
125
NPV = $538 = accept
4- 11
NPV Profile of Project
2500
2000
NPV
1500
IRR = 18.5%
1000
500
0
0
5
10
15
-500
Discount rate
20
25
Sensitivity Analysis
Use of Jell-O Facilities
4- 12
Ye a r
0
1
2
3
4
5
6
7
8
9
10
11
Tota l
De precia tion Ta x
PV of
Ex pe nse
She lte r
Ca sh Flow
Foregone
Foregone a t 10%
$453
$46
$24
(22)
43
22
(18)
41
21
(16)
38
20
(13)
35
18
(11)
33
17
(10)
30
16
(8)
26
14
(6)
24
12
(5)
21
11
(4)
60
(21)
$317
Sensitivity Analysis
Overhead
4- 13
Ove rhe a d
Sa vings
Ye a r
0
1
2
3
4
5
6
7
8
9
10
11
Tota l
Afte r
Ta x
CF
$90
90
90
90
90
90
PV of
Ca sh Flow
a t 10%
$43
43
43
43
43
43
0
0
0
0
$27
24
22
20
18
17
$129
Sensitivity Analysis
Erosion
4- 14
Contribution
Loss from
Erosion
Year
0
1
2
3
4
5
6
7
8
9
10
11
Total
$180
200
210
220
230
230
240
240
250
250
After tax
Cash Flow
($86)
($96)
($101)
($106)
($110)
($110)
($115)
($115)
($120)
($120)
PV of
Cash Flow
at 10%
(79)
(79)
(76)
(72)
(69)
(62)
(59)
(54)
(51)
(46)
($647)
4- 15
NPV Sensitivity Analysis
JELLO FACILITIES
OVERHEAD
yes
yes
EROSION
(109)
no
yes
yes
(109)
no
208
no
yes
538
yes
no
(109)
538
20
208
337
538
538
no
yes
855
667
855
no
no
984