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Jacobs Division 2003
Richard Soderberg, financial analyst for the Jacobs Division of MacFadden Chemical
Company, was reviewing several complex issues relating to possible investment in a new product
for the following year, 2004. The product was a specialty coating material, which qualified for
investment according to company guidelines. Mr. Reynolds, however, the Jacobs Division
manager, was fearful that it might be too risky. While regarding the project as an attractive
opportunity, Mr. Soderberg believed that the only practical way to sell the product in the short
run would place it in a weak competitive position over the long run. He was also concerned that
the estimates used in the probability analysis were little better than educated guesses.
This case is based on the Jacobs Division prepared by Professors Diana Harrington and Robert Vandell. The case
has been updated and revised by Professor Robert Conroy. The case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2003 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send
an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

2. Company Background
MacFadden Chemical Company was one of the larger chemical firms in the world, with
sales in excess of $10 billion. Its volume had grown steadily at the rate of 10 percent per year
throughout the 1980s until 1993; sales and earnings had grown more rapidly. Beginning in 1993,
the chemical industry began to experience overcapacity, particularly in basic materials, which led
to price cutting. Also, more funds had to be spent in marketing and research for firms to remain
competitive. As a consequence of the industry problems, MacFadden achieved only a modest
growth of 4 percent in sales in the 1990’s and experienced an overall decline in profits. Certain
shortages began developing in the economy in 2002, however, and by 2003, sales had risen 60
percent and profits over 100 percent as the result of price increases and near-capacity operations.
Most observers believed that the shortage boom would be only a short respite from the
intensely competitive conditions of the last decade.
The 11 operating divisions of MacFadden were organized into three groups. Most
divisions had a number of products centered on one chemical, such as fluoride, sulphur, or
petroleum. The Jacobs Division was an exception.
It was the newest and, with sales of $100 million, the smallest division. Its products were
specialty industrial products with various chemical bases, such as dyes, adhesives, and finishes,
which were sold in relatively small lots to diverse industrial customers. No single product had
sales over $5 million, and many had sales of only $500,000. There were 150 basic products in the
division, each with several minor variations. Jacobs was one of MacFadden’s more rapidly
growing divisions --12 percent per year prior to 2003--with a 13 percent return on total net
assets.
Capital Budgeting for New Projects
Corporate-wide guidelines were used for analyzing new investment opportunities. In the
current environment the long-term risk-free rate was about 6percent. At the firm level, the return
criteria were 8 percent for cost-reduction projects, 12 percent for expansion of facilities, and 16
percent for new products or processes. Returns were measured in terms of discounted cash flows
after taxes. Mr. Soderberg believed that these rates and methods were typical of those used
throughout the chemical industry.
Mr. Reynolds tended, however, to demand higher returns for projects in his division, even
though its earnings-growth stability in the past marked it as one of MacFadden’s more reliable
operations. Mr. Reynolds had three reasons for wanting better returns than corporate
requirements. First, one of the key variables used in appraising management performance at
This case is based on the Jacobs Division prepared by Professors Diana Harrington and Robert Vandell. The case
has been updated and revised by Professor Robert Conroy. The case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2003 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send
an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

3. MacFadden was the growth of residual income, although such aspects as market share and profit
margins were also considered.1
Mr. Reynolds did not like the idea of investing in projects that
were close to the target rate of earnings imbedded in the residual-income calculation.
Second, many new projects had high start-up costs. Even though they might achieve
attractive returns over the long run, such projects hurt earnings performance in the short run.
“Don’t tell me what a project’s discount rate of return is; tell me whether we’re going to improve
our return on total net assets within three years,” Mr. Reynolds would say. Third, Mr. Reynolds
was skeptical of estimates. “I don’t know what’s going to happen here on this project, but I’ll bet
we overstate returns by 2 to 5 percent on average,” was a typical comment. He therefore tended
to look for at least 4 percent more than the company standard before becoming enthusiastic about
a project. “You’ve got to be hard-nosed about taking risk,” he said. “By demanding a decent
return for riskier opportunities, we have a better chance to grow and prosper.”
Mr. Soderberg knew that Mr. Reynolds’s views were reflected in decisions throughout the
division. Projects that did not have promising returns according to Mr. Reynolds’s standards
were often dropped or shelved early in the decision process. Mr. Soderberg guessed that at
Jacobs almost as many projects with returns meeting the company hurdle rates were abandoned as
were ultimately approved. In fact, the projects that were finally submitted to Mr. Reynolds were
usually so promising that he rarely rejected them. Capital projects from his division were
accepted virtually unchanged, unless top management happened to be unusually pessimistic about
prospects for business and financing in general.
The Silicone-X Project
A new product was often under study for several years after research had developed a
“test tube” idea. The product had to be evaluated relative to market needs and competition. The
large number of possible applications of any product complicated this analysis. At the same time,
technological studies were undertaken to examine such factors as material sources, plant location,
manufacturing-process alternatives, and economies of scale. While a myriad of feasible
alternatives existed, only a few could be actively explored, and they often required outlays of
several hundred thousand dollars before the potential of the project could be ascertained. “For
every dollar of new capital approved, I bet we spend $0.30 on the opportunities,” observed Mr.
Soderberg, “and that doesn’t count the money we spend on research.”
The project that concerned Mr. Soderberg at the moment was called Silicone-X, a
special-purpose coating that added slipperiness to a surface. The coating could be used on a
1Residual income was the division’s profit after allocated taxes minus a 10-percent capital charge on total
assets after depreciation.
This case is based on the Jacobs Division prepared by Professors Diana Harrington and Robert Vandell. The case
has been updated and revised by Professor Robert Conroy. The case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2003 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send
an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

4. variety of products to reduce friction, particularly where other lubricants might imperfectly
eliminate friction between moving parts. Its uniqueness lay in its hardness, adhesiveness to the
applied surface, and durability. The product was likely to have a large number of buyers, but
most of them could use only small quantities: only a few firms were likely to buy amounts greater
than 5,000 pounds per year.
Test-tube batches of Silicone-X had been tested both inside and outside the Jacobs
Division. Comments were universally favorable, although $2.00 per pound seemed to be the
maximum price that would be acceptable. Lower prices were considered unlikely to produce
larger volume. For planning purposes, a price of $1.90 per pound had been used.
Demand was difficult to estimate because of the variety of possible applications. The
division’s market-research group had estimated a first year demand of 1 to 2 million pounds with
1.2 million cited as most likely. Mr. Soderberg commented, “They could spend another year
studying it and be more confident, but we wouldn’t find them more believable. The estimates are
educated guesses by smart people. However, they are also pretty wild stabs in the dark. They
won’t rule out the possibility of demand as low as 500,000 pounds, and 2 million pounds is not
the ceiling.” Mr. Soderberg empathized with the problem facing the market-research group.
They tried to do a systematic job of looking at the most probable applications, but the data were
not good.
The market researchers believed that, once the product became established, average
demand would probably grow at a healthy rate, perhaps 10 percent per year. However, the
industries served were likely to be cyclical with volume requirements swinging 20 percent
depending on market conditions. The market researchers concluded, “We think demand should
level off after eight to ten years, but the odds are very much against someone developing a
cheaper or markedly superior substitute.”
On the other hand, there was no patent protection on Silicone-X, and the technological
know-how involved in the manufacturing process could be duplicated by others in perhaps as little
as 12 months. “This product is essentially a commodity, and someone is certainly going to get
interested in it when sales volume reaches $3 million,” observed Mr. Soderberg.
The cost estimates looked solid. Mr. Soderberg continued, “Basic chemicals, of course,
fluctuate in purchase price, but we have a captive source with stable manufacturing costs. We can
probably negotiate a long-term transfer price with Wilson [another MacFadden division], although
this is not the time to do so.”
Project Analysis
This case is based on the Jacobs Division prepared by Professors Diana Harrington and Robert Vandell. The case
has been updated and revised by Professor Robert Conroy. The case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2003 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send
an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

5. In his preliminary analysis, Mr. Soderberg used a discount rate of 20 percent and a project
life of 15 years, because most equipment for the project was likely to wear out and need
replacement during that time frame.
“We also work with most likely estimates. Until we get down to the bitter end, there are
too many alternatives to consider, and we can’t afford probabilistic measures or fancy simulations.
A conservative definition of most likely values is good enough for most of the subsidiary analyses.
We’ve probably made over 200 present-value calculations using our computer programs just to
get to this decision point, and heaven knows how many quick-and-dirty paybacks,” observed Mr.
Soderberg. “We’ve made a raft of important decisions that affect the attractiveness of this
project. Some of them are bound to be wrongI hope not critically so. In any case, these
decisions are behind us. They’re buried so deep in the assumptions, no one can find them, and
top management wouldn’t have time to look at them anyway.”
With Silicone-X, Mr. Soderberg was down to a labor-intensive, limited-capacity approach
and a capital-intensive method. “The analyses all point in one direction,” he said, “but I have the
feeling it’s going to be the worst one for the long run.”
The labor-intensive method involved an initial plant and equipment outlay of $900,000. It
could produce 1.5 million pounds per year. “Even if the project bombs out, we won’t lose much.
The equipment is very adaptable. We could find uses for about half of it. We could probably sell
the balance for $200,000, and let our tax write-offs cover most of the rest. We should salvage the
working-capital part without any trouble. The start-up costs and losses are our real risks,”
summarized Mr. Soderberg. “We’ll spend $50,000 debugging the process, and we’ll be lucky to
satisfy half the possible demand. However, I believe we can get this project on stream in one
year’s time.”
Exhibit 1 shows Mr. Soderberg’s analysis of the labor-intensive alternative. His
calculations showed a small net present value when discounted at 20 percent and a sizable net
present value at 8 percent. When the positive present values were compared with the negative
present values, the project looked particularly attractive.
The capital-intensive method involved a much larger outlay for plant and equipment: $3.3
million. Manufacturing costs would, however, be reduced by $0.35 per unit and fixed costs by
$100,000, excluding depreciation. The capital-intensive plant was designed to handle 2.0 million
pounds, the lowest volume for which appropriate equipment could be acquired. Since the
equipment was more specialized, only $400,000 of this machinery could be used in other company
activities. The balance probably had a salvage value of $800,000. It would take two years to get
This case is based on the Jacobs Division prepared by Professors Diana Harrington and Robert Vandell. The case
has been updated and revised by Professor Robert Conroy. The case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2003 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send
an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

6. the plant on stream, and the first year’s operating volume was likely to be low--perhaps 700,000
pounds at the most. Debugging costs were estimated to be $100,000.
Exhibit 2 presents Mr. Soderberg’s analysis of the capital-intensive method. At a
20-percent discount rate, the capital-intensive project had a large negative present value and thus
appeared much worse than the labor-intensive alternative. However, at an 8-percent discount
rate, it looked significantly better than the labor-intensive alternative.
Problems in the Analysis
Several things concerned Mr. Soderberg about the analysis. Mr. Reynolds would only look
at the total return. Thus the capital-intensive project would not be acceptable. Yet, on the basis
of the breakeven analysis, the capital-intensive alternative seemed the safest way to start. It
needed sales of just 325,900 pounds to break even, while the labor-intensive method required
540,000 pounds (see Exhibit 3).
Mr. Soderberg was concerned that future competition might result in price cutting. If the
price per pound fell by $0.20, the labor-intensive method would not break even unless 900,000
pounds were sold. Competitors could, once the market was established, build a capital-intensive
plant that would put them in a good position to cut prices by $0.20 or more. In short, there was a
risk, given the labor-intensive solution, that Silicone-X might not remain competitive. The better
the demand proved to be, the more serious this risk would become. Of course, once the market
was established, Jacobs could build a capital-intensive facility, but almost none of the
labor-intensive equipment would be useful in such a new plant. The new plant would still cost
$3.3 million, and Jacobs would have to write off losses on the labor-intensive facility.
The labor-intensive facility would be difficult to expand economically. It would cost
$50,000 for each 100,000 pounds of additional capacity (only practical in 250,000-pound
increments). In contrast, an additional 100,000 pounds of capacity in the capital-intensive unit
could be added for $25,000.
The need to expand, however, would depend on sales. If demand remained low, the
project would probably return a higher rate under the labor-intensive method. If demand
developed, the capital-intensive method would clearly be superior. This analysis led Mr.
Soderberg to believe that his breakeven calculations were somehow wrong.
Pricing strategy was another important element in the analysis. At $1.90 per pound,
Jacobs could be inviting competition. Competitors would be satisfied with a low rate of return,
perhaps 12 percent, in an established market. At a price lower than $1.90, Jacobs might
This case is based on the Jacobs Division prepared by Professors Diana Harrington and Robert Vandell. The case
has been updated and revised by Professor Robert Conroy. The case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2003 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send
an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

7. discourage competition. Even the labor-intensive alternative would not provide a rate of return of
20 percent at any lower price. It began to appear to Mr. Soderberg that using a high discount
rate was forcing the company to make a riskier decision than would a lower rate and was
increasing the chance of realizing a lower rate of return than had been forecast.
Mr. Soderberg was not sure how to incorporate pricing into his analysis. He knew he
could determine what level of demand would be necessary to encourage a competitor, expecting a
50-percent share and needing a 12 percent return on a capital-intensive investment, to enter the
market at a price of $1.70, or $1.90, but this analysis did not seem to be enough.
Finally, Mr. Soderberg was concerned about the volatility of demand estimates on which
he had based the analysis. He reviewed some analysts’ reports and found some information on
firms that were in businesses similar to Silicone_X. Based on these firms’ stock market returns he
estimated that the volatility of returns for this line of business was around .35.
Mr. Soderberg’s job was to analyze the alternatives fully and recommend one of them to
Mr. Reynolds. On the simplest analysis, the labor-intensive approach seemed best. Even at 20
percent, its present value was positive. That analysis, however, did not take other factors into
consideration.
This case is based on the Jacobs Division prepared by Professors Diana Harrington and Robert Vandell. The case
has been updated and revised by Professor Robert Conroy. The case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2003 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send
an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval
system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

8. Exhibit 1
THE JACOBS DIVISION 2003
Analysis of Labor-Intensive Alternative for Silicone-X
(dollars in thousands, except per-unit data)
Year
0 1 2 3 4 5-15
Investments
Plant and equipment $ 900
Working capital $ 140 $ 14 $ 15 $ 17 $ 20
Demand (thousands of pounds) 1,200 1,320 1,452 1,597 N.A.
Capacity (thousands of pounds) 600 1,500 1,500 1,500 1,500
Sales (thousands of pounds) 600 1,320 1,452 1,500 1,500
Sales price/unit $1.90 $1.90 $1.90 $1.90 $1.90
Variable costs/unit
Manufacturing 1.30 1.30 1.30 1.30 1.30
Marketing 0.10 0.10 0.10 0.10 0.10
Total variable costs/unit 1.40 1.40 1.40 1.40 1.40
Contribution/unit 0.50 0.50 0.50 0.50 0.50
Contribution in dollars 300 660 726 750 750
Fixed costs
Overhead 210 210 210 210 210
Depreciation 60 60 60 60 60
Start-up costs 50 0 0 0 0
Total fixed costs 320 270 270 270 270
Profit before taxes (20) 390 456 480 480
Profit after taxes (taxes @50%) (10) 195 228 240 240
Cash flow from operations
(Profit after taxes + depreciation) 50 255 288 300 300
Total cash flow $(900) $ (90) $ 241 $ 273 $ 283 280
Terminal value (year 15) $ 381
N.A. = not available.
Exhibit 2
THE JACOBS DIVISION 2003

9. Analysis of Capital-Intensive Alternative for Silicone-X
(dollars in thousands, except per-unit data)
Year
0 1 2 3 4 5 6 7-15
Investments
Plant and equipment $ 1,900 $ 1,400
Working capital $ 160 $ 11 $ 17 $ 20 $ 24 $ 30
Demand (thousands of
pounds) 1,320 1,452 1,597 1,757 1,933 2,125
Capacity (thousands of
pounds) 700 2,000 2,000 2,000 2,000 2,000
Sales (thousands of pounds) 700 1,452 1,597 1,757 1,933 2,000
Sales price/unit $1.90 $1.90 $1.90 $1.90 $1.90 $1.90
Variable costs/unit
Manufacturing 0.95 0.95 0.95 0.95 0.95 0.95
Selling 0.10 0.10 0.10 0.10 0.10 0.10
Total variable costs/unit 1.05 1.05 1.05 1.05 1.05 1.05
Contribution/unit 0.85 0.85 0.85 0.85 0.85 0.85
Contribution in dollars 595 1,234 1,357 1,493 1,643 1,700
Fixed costs
Overhead 110 110 110 110 110 110
Depreciation 167 167 167 167 167 167
Start-up costs 100 0 0 0 0 0
Total fixed costs 377 277 277 277 277 277
Profit before taxes 218 957 1,081 1,217 1,366 1,423
Profit after taxes
(taxes @50%) 109 479 540 608 683 712
Cash flow from operations
(Profit after taxes +
depreciation) 276 646 707 775 850 879
Total cash flow $(1,900) $(1,400) $ 116 $ 635 $ 690 755 $ 826 849
Terminal value (year 15) $1,384

10. Exhibit 3
THE JACOBS DIVISION 2003
Breakeven Analysis for Silicone-X
Labor Capital
Intensive Intensive
Normal ($1.90 price)
Fixed costs
Operations $210,000 $110,000
Depreciation 60,000 167,000
Total $270,000 $277,000
Contribution per unit $0.50 $0.85
Units to breakeven 540,000 325,882
Price Competitive ($1. 70 price)
Contribution per unit $0.3 $0.65
Units to breakeven 900,000 426,154