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  • 1. Valuation of the Super ProjectGroup Members:XXX XXXXXXXX XXXXXGordon SchwabeXXX XXXXX 27.01.2013
  • 2. AGENDA 1. Case summary 2. Problem statement 3. Clarifying problems & solutions 4. Comments on the 3 evaluation approaches 5. Recommendations on evaluation 6. Cash flow statement 7. ConclusionValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 2
  • 3. Case Summary • General Foods is a large corporation organized by productl • Super is a proposed new instant desert, based on a “flavored, water- soluble, agglomerated powder.” • General Foods has numerous projects with a strict criteria to judge their value for the company • There are basically three types of capital investment proposals at General Foods: • Safety • Quality • Increased profitValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 3
  • 4. Problem Statement • 3 methods, each passes with advantages and disadvantages • Incremental / Facilities used / Fully allocated • Memos indicate that General Foods’ finance personnel are questioning the same criteria’s ability to accurately reflect the value of the Super project • No precise estimation of company value, because of the high variance in the evaluation methodsValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 4
  • 5. Problem Statement – What is ROFE? GF uses Return On Funds Employed (ROFE) to evaluate the viability of capital projects, and to weigh one project against another to determine prioritization. ROFE = EBIT / Capital Invested (book value)  Ratio of EARNINGS created from the book value of capital invested • Using EBIT, does not capture net operating cash flow • Uses book value (depreciated value) of capital investments • If capital assets are depreciated, they appear to create a cash flow • Depreciation is an accounting expense not a cash flow • Artificially biases long-term asset-intensive projects, as they have bigger apparent depreciation cash flows • Does not capture the time value of money; interest and inflation ROFE is not a tool to evaluate capital projects. Even used as a metric to compare capital earnings performance, it has flaws.Valuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 5
  • 6. Problem Statement - How we should deal with… • Test-market expenses • Erosion of Jell-O contribution margin • Allocation of charges for the use of excess agglomerator capacity • Overhead expensesValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 6
  • 7. Test-market expenses • Should only be taken into account if they can be attributed to the particular project • In the Super case these expenses had been made before the Super project had started  Will not be taken into account in the FCFValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 7
  • 8. Erosion of Jell-O contribution margin • Super will displace part of Jell-O´s market share  Erosion of Jell-O contribution margin should be taken into accountValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 8
  • 9. Allocation of charges for the use of excess agglomerator capacity • Not counted in the FCF of the Super Project • Charges represent opportunity costs for the Jell-O devision or future projects  Take costs into account on a corporate levelValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 9
  • 10. Erosion of Jell-O contribution margin • Should be taken into account if they can be attributed to the particular project  General Foods Corp. already counted theses costs in the CF of Jell-OValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 10
  • 11. Overhead Expenses • Should be taken into account if these expenses can be attributed to Super • Overhead expenses for the Super Project are not clearly defined  Overhead expenses will be taken into account in the FCFValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 11
  • 12. Incremental Basis• This evaluation approach uses only directly identified cash flows Only incremental approaches has been taken into account Jell-O facilities and production capacity are not relevant for Super because they have already been counted in the CF.This execution of Incremental Basis is flawed because it:• Includes sunk costs (the marketing study)• Fails to account for relevant increasing overhead costs.• Fails to take into account income-tax-reducing depreciation.• Utilizes ROFE. Again, ROFE is no good for capital budgetingValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 12
  • 13. Facilities-Used Basis• Super will use 1/2 of Jell-O’s agglomerator• Super will use 2/3 of Jell-O’s building• Super “pro-rata” share is $453 K• Charges Super with the facility overhead ($28k p/y). This approach• In the capital budgeting process only incremental cash flows are taken into account.• Only shifts costs ($453K in facilities) to Super, which is an accounting maneuver and does not effect the cashflow• It’s a “net zero” method, it just moves costs Useful for accounting, not for capital budgetingValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 13
  • 14. Fully Allocated Basis Facilities-Used Basis + overhead expenses• Overhead expenses: • Selling, general and administrative costs This approach• Gives the most inclusive analysis of existing cash flow• Adds overhead costs correctlyValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 14
  • 15. Evaluation of the Super Project GF can do this by: 1. Taking into account incremental cash flows 2. Modifying their income statement to deduct depreciation before calculating tax 3. Ignore sunk costs (marketing test, Jell-O facilities, etc.) 4. Remove depreciation from capital assets for purposes of evaluation 5. Accept overhead from growth/doubling powdered dessert lineValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 15
  • 16. Recommendations evaluation of the Super Project• $200k for high speed filling/packaging equipment, finish packing room• $360k market test – irrelevant• Opportunity cost for Jell-O’s facilities and equipment • Not relevant – same opportunity for any project using this building • From corporate POV, hard to sell to move in some business to utilize temporarily excess Jell-O facilities, low feasibility• Capital depreciation – non-cash expense – irrelevant• Capital depreciation expense tax deduction – relevant to operating cash flow• Shift $453k pro-rata share of Jell-O facilities and agglomerator – Incremental test – irrelevantValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 16
  • 17. Recommendations Evaluation of the Super Project• $28k avg. yearly depreciation of Jell-O facilities – Incremental test – irrelevant• $19k business expansion capital for distribution system – Incremental test – relevant• Expansion capital depreciation expense tax deduction – relevant to operating cash flow• $90k additional yearly overhead expense for business expansion – Incremental test – relevantValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 17
  • 18. Free Cash Flow 400.00 200.00 0.00Amount -200.00 -400.00 -600.00 -800.00 1 2 3 4 5 6 7 8 9 10 11 FCF Incremental -200 -518 -5.4 5.17 86.1 246. 221. 233. 245. 263. 303. FCF Facility used -453 -518 6.42 16.3 96.7 256. 229. 241. 253. 269. 345. FCF Fully Allocated -672 -518 6.42 16.3 96.7 212. 186. 198. 210. 226. 333. Valuation of the Super Project 27.01.2013 Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 18
  • 19. Free Cash Flow Net Sales Net Earnings Discount rate 4,66% 7,69% NPV 447,59 248,64 IRR 13% 13% Net Sales Net Earnings Discount rate 4,66% 7,69% NPV 280,38 67,31 IRR 9% 9% Net Sales Net Earnings Discount rate 4,66% 7,69% NPV -102,79 -286,13 IRR 3% 3%Valuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 19
  • 20. Conclusion- An expansion or broadening of market capture by appealing to somewhat parallel consumer needs- Take advantage of short term availability of Jell-O facilities - in the long term it is not a better project just because it fits a facility that is temporarily unusedMain Points:- NPV is in 2 approaches positive- IRR is in 2 approaches higher than discount rate (decision premise)- Payback after the 6th year (shorter than normal payback period) Do the investmentValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 20
  • 21. Fachbereich WirtschaftThank you for your attention
  • 22. Appendix – Incremental CFValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 22
  • 23. Appendix – Facility Used CFValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 23
  • 24. Appendix – Fully Allocated CFValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 24
  • 25. Appendix – Excel File Excel FileValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 25
  • 26. Appendix - DepreciationValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 26
  • 27. Appendix – Opportunity costsValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 27
  • 28. Appendix – Erosion of Jell-OValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 28
  • 29. Appendix – Tax rateValuation of the Super Project 27.01.2013Fachhochschule Brandenburg · University of Applied Sciences · Fachbereich Wirtschaft Page 29

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