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Transcript of Super
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 ProductDesign
MarketTesting
ManufacturingInvestment
WorkingCapital
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 2 3 4 5 6 7 8 9 10Net sales $2,112 $2,304 $2,496 $2,688 $2,880 $2,880 $3,072 $3,072 $3,264 $3,264COGS $1,100 $1,200 $1,300 $1,400 $1,500 $1,500 $1,600 $1,600 $1,700 $1,700Gross profit 1,012 1,104 1,196 1,288 1,380 1,380 1,472 1,472 1,564 1,564Advertising expense 1,100 1,050 1,000 900 700 700 730 730 750 750Increased overhead 90 90 90 90 90 90Depreciation 46 43 41 38 35 33 30 26 24 21Start-up costs 15
Profit before taxes ($149) $11 $155 $350 $555 $557 $622 $626 $700 $703Taxes (@52%) (77) 6 81 182 289 290 323 326 364 366
Net Profit (72) 5 74 168 266 267 299 300 336 337Depreciation 65 61 58 54 50 46 42 37 34 30
Cash flow (7) $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 Flows0 ($200) ($453) $8 ($645)1 ($329) (7) (336)2 55 66 1213 3 132 1354 7 222 2295 23 316 3396 (1) 313 3127 (13) 341 3288 0 337 3379 (12) 370 358
10 0 367 36711 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 PV
0 $645 1/(1.1)0=1 $6451 $336 0.909 $3052 $121 0.826 100
3 $135 0.751 101
4 $229 0.683 156
5 $339 0.621 211
6 $312 0.564 176
7 $328 0.513 168
8 $337 0.467 157
9 $358 0.424 152
10 $367 0.386 142
11 $358 0.350 125
NPV = $538 = accept
4- 11
NPV Profile of Project
-500
0
500
1000
1500
2000
2500
0 5 10 15 20 25
Discount rate
NP
V IRR = 18.5%
4- 12 Sensitivity Analysis Use of Jell-O Facilities
Depreciation Tax PV ofExpense Shelter Cash Flow
Year Foregone Foregone at 10%0 $4531 $46 $24 (22)2 43 22 (18)3 41 21 (16)4 38 20 (13)5 35 18 (11)6 33 17 (10)7 30 16 (8)8 26 14 (6)9 24 12 (5)
10 21 11 (4)11 60 (21)
Total $317
4- 13 Sensitivity AnalysisOverhead
After PV ofOverhead Tax Cash Flow
Year Savings CF at 10%01 02 03 04 05 $90 $43 $276 90 43 247 90 43 228 90 43 209 90 43 18
10 90 43 1711
Total $129
4- 14 Sensitivity Analysis Erosion
Contribution PV ofLoss from After tax Cash Flow
Year Erosion Cash Flow at 10%01 $180 ($86) (79)2 200 ($96) (79)3 210 ($101) (76)4 220 ($106) (72)5 230 ($110) (69)6 230 ($110) (62)7 240 ($115) (59)8 240 ($115) (54)9 250 ($120) (51)
10 250 ($120) (46)11
Total ($647)
4- 15
NPV Sensitivity Analysis
538
(109)
538
yes
no
EROSION
208
(109)
538
855
JELLO FACILITIES
no
yes
no
yes
OVERHEAD
(109)
20
208
337
538
667
855
984
yes
no
yes
yes
yes
no
no
no