write executive summary the project

Lecturer Harold E. Wyman prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. This case was made possible by the cooperation of General Fods Corporation. Copyright © 1967 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.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 Harvard Business School.

The Super Project

In March 1967, Crosby Sanberg, manager-financial analysis at General Foods Corporation, told a casewriter, “What I learned about incremental analysis at the Business School doesn’t always work.” He was convinced that under some circumstances sunk costs were relevant to capital project evaluations. He was also concerned that financial and accounting systems did not provide an accurate estimate of incremental costs and revenues, and that this was one of the most difficult problems in measuring the value of capital investment proposals. Sanberg used the Super project1 as an example.

Super was a new instant dessert, based on a flavored, water-soluble, agglomerated2 powder. Although four flavors would be offered, it was estimated that chocolate would account for 80% of total sales.

General Foods was organized along product lines in the United States, with foreign operations under a separate division. Major U.S. product divisions included Post, Kool-Aid, Maxwell House, Jell-O, and Birds Eye. Financial data for General Foods are given in Exhibits 1, 2, and 3.

The $200,000 capital investment project request for Super involved $80,000 for building modifications and $120,000 for machinery and equipment. Modifications would be made to an existing building, where Jell-O was manufactured. Since available capacity of a Jell-O agglomerator would be used in the manufacture of Super, no cost for the key machine was included in the project. The $120,000 machinery and equipment item represented packaging machinery.

Table A Dessert Market, August–September 1966 Compared with August– September 1965

Change From Aug.-Sept. 1965

Aug.-Sept.1966 Share Points Volume (%) Jell-O 19.0% 3.6 40.0 Tasty 4.0 4.0 (new)

Total powders 25.3 7.6 62.0 Pie fillings and cake mixes 32.0 -3.9 (no change) Ice cream 42.7 -3.4 5.0

Total market 100.0% 13.0

1The name and nature of this new product have been disguised to avoid the disclosure of confidential information.

2Agglomeration is a process by which the processed powder is passed through a steam bath and then dried. This fluffs up the powder particles and increases solubility.

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112-034 The Super Project

2

The Market

A Nielsen survey indicated that powdered desserts constituted a significant and growing segment of the total dessert market, as shown in Table A. On the basis of test market experience, General Foods expected Super to capture a 10% share of the total dessert market. Eighty percent of this expected Super volume would come from growth in total market share or growth in the powders segment, and 20% would come from erosion of Jell-O sales.

Production Facilities

Test market volume was packaged on an existing line, inadequate to handle long-run requirements. Filling and packaging equipment to be purchased had a capacity of 1.9 million units on a two-shift, five-day workweek basis. This represented considerable excess capacity, since 1968 requirements were expected to reach 1.1 million units, and the national potential was regarded as 1.6 million units. However, the extra capacity resulted from purchasing standard equipment, and a more economical alternative did not exist.

Capital Budgeting Procedure

The General Foods Accounting and Financial Manual identified four categories of capital investment project proposals: (1) safety and convenience; (2) quality; (3) increase profit; and (4) other. Proposal procedures and criteria for accepting projects varied according to category (see Exhibit 4). In discussing these criteria, Sanberg noted that the payback and return guidelines were not used as cut-off measures and added:

Payback and return on investment are rarely the only measure of acceptability. Criteria vary significantly by type of project. A relatively high return might be required for a new product in a new business category. On the other hand, a much lower return might be acceptable for a new product entry which represented a continuing effort to maintain leadership in an existing business by, for example, filling out the product line.

Super fell into the third category, as a profit-increasing project. Estimates of payback and return on funds employed were required for each such project requiring $50,000 or more of new capital funds and expense before taxes. The payback period was the length of time required for the project to repay the investment from the date the project became operational. In calculating the repayment period, only incremental income and expenses related to the project were used.

Return on funds employed (ROFE) was calculated by dividing 10-year average profit before taxes by the 10-year average funds employed. Funds employed included incremental net fixed assets plus or minus related working capital. Start-up costs and any profits or losses incurred before the project became operational were included in the first profit and loss period in the financial evaluation calculation.

Capital Budgeting Atmosphere

A General Foods accounting executive commented on the atmosphere within which capital projects were reviewed:

Our problem is not one of capital rationing. Our problem is to find enough good solid projects to employ capital at an attractive return on investment. Of course, the rate of capital inputs must be balanced against a steady growth in earnings per share. The short-term impact

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The Super Project 112-034

3

of capital investments is usually an increase in the capital base without an immediate realization of profit potential. This is particularly true in the case of new products.

The food industry should show a continuous growth. A cyclical industry can afford to let its profits vary. We want to expand faster than the gross national product. The key to our capital budgeting is to integrate the plans of our eight divisions into a balanced company plan which meets our overall growth objectives. Most new products show a loss in the first two or three years, but our divisions are big enough to introduce new products without showing a loss.

Documentation for the Super Project

Exhibits 5 and 6 document the financial evaluation of the Super project. Exhibit 5 is the summary appropriation request prepared to justify the project to management and to secure management’s authorization to expend funds on a capital project. Exhibit 6 presents the backup detail. Cost of the market test was included as “Other” expense in the first period because a new product had to pay for its test market expense, even though this might be a sunk cost at the time capital funds were requested. The “Adjustments” item represented erosion of the Jell-O market and was calculated by multiplying the volume of erosion times a variable profit contribution. In the preparation of this financial evaluation form, costs of acquiring packaging machinery were included but no cost was attributed to Jell-O agglomerator capacity to be used for the Super project because the General Foods Accounting and Financial Manual specified that capital project requests be prepared on an incremental basis:

The incremental concept requires that project requests, profit projections, and funds- employed statements include only items of income and expense and investment in assets which will be realized, incurred, or made directly as a result of, or are attributed to, the new project.

Exchange of Memos on the Super Project

After receiving the paperwork on the Super project, Sanberg studied the situation and wrote a memorandum arguing that the incremental approach advocated by the manual should not be applied to the Super project. His superior agreed with the memorandum and forwarded it to the corporate controller with the covering note contained in Appendix A. The controller’s reply is given in Appendix B.

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112-034 The Super Project

4

Exhibit 1 Consolidated Balance Sheet of General Foods Corporation, Fiscal Year Ended April 1, 1967 ($ millions)

Assets

Cash $ 20 Marketable securities 89 Receivables 180 Inventories 261 Prepaid expenses 14

Current assets 564 Land, buildings, equipment (at cost, less depreciation) 332 Long-term receivables and sundry assets 7 Goodwill 26

Total $929

Liabilities and Stockholders’ Equity Notes payable $ 22 Accounts payable 86 Accrued liabilities 73 Accrued income taxes 57

Current liabilities 238 Long-term notes 39 3-3/8% debentures 22 Other noncurrent liabilities 10 Deferred investment tax credit 9 Stockholders’ equity

Common stock issued 164 Retained earnings 449 Common stock held in treasury, at cost (2)

Stockholders’ equity 611 Total $929

Common stock—shares outstanding at year-end (millions) 25.127

Exhibit 2 Common Stock Prices of General Foods Corporation, 1958-1967

Year Low High

1958 $24 $39 1959 37-1/8 53-7/8 1960 49-1/8 75-1/2 1961 68-5/8 107 1962 57 96 1963 77-5/8 90-1/2 1964 78-1/4 93-1/4 1965 77-1/2 89-7/8 1966 62 83 1967 65-1/4 81

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112-034 -5-

Exhibit 3 Summary of Statistical Data of General Foods Corporation, Fiscal Year 1958–1967 ($ millions, except assets per employee and figures on a share basis)

1958 1959 1960 1961 1962 1963 1964 1965 1966 1967

Income Statement Sales to customers (net) $1,009 $1,053 $1,087 $1,160 $1,189 $1,216 $1,338 $1,478 $1,555 $1,652 Cost of sales 724 734 725 764 769 769 838 937 965 1,012 Marketing, administrative and general expenses 181 205 236 261 267 274 322 362 406 449 Earnings before income taxes 105 115 130 138 156 170 179 177 185 193 Taxes on income 57 61 69 71 84 91 95 91 91 94 Net earnings $48 $54 $61 $67 $72 $79 $84 $86 $94 $99 Dividends on common shares 24 28 32 35 40 45 50 50 53 55 Retain earnings—current year 24 26 29 32 32 34 34 36 41 44 Net earnings per common sharea $1.99 $2.21 $2.48 $2.69 $2.90 $3.14 $3.33 $3.44 $3.73 $3.93 Dividends per common sharea 1.00 1.15 1.30 1.40 1.60 1.80 2.00 2.00 2.10 2.20 Assets, Liabilities, and Stockholders’ Equity Inventories 169 149 154 189 183 205 256 214 261 261 Other current assets 144 180 200 171 204 206 180 230 266 303 Current liabilities 107 107 126 123 142 162 202 173 219 238 Working capital 206 222 230 237 245 249 234 271 308 326 Land, buildings, equipment, gross 203 221 247 289 328 375 436 477 517 569 Land, buildings, equipment, net 125 132 148 173 193 233 264 283 308 332 Long-term debt 49 44 40 37 35 34 23 37 54 61 Stockholders’ equity 287 315 347 384 419 454 490 527 569 611 Stockholders’ equity per common sharea 11.78 12.87 14.07 15.46 16.80 18.17 19.53 20.99 22.64 24.32 Capital Program Capital additions 28 24 35 40 42 57 70 54 65 59 Depreciation 11 14 15 18 21 24 26 29 32 34 Employment Data Wages, salaries, and benefits $128 $138 $147 $162 $171 $180 $195 $204 $218 $237 Number of employees (in thousands) 21 22 22 25 28 28 30 30 30 32 Assets per employee ($ thousands) $21 $22 $23 $22 $22 $23 $24 $25 $29 $29

aPer share figures calculated on shares outstanding at year-end and adjusted for 2-for-1 stock split in August 1960.

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112-034 The Super Project

6

Exhibit 4 Criteria for Evaluating Projects by General Foods Corporation

The basic criteria to be applied in evaluating projects within each of the classifications are set forth in the following schedule:

Purpose of Project a. Safety and Convenience:

1. Projects required for reasons of safety, sanitation, health, public convenience, or other over-riding reason with no reasonable alternatives. Examples: sprinkler systems, elevators, fire escapes, smoke control, waste disposal, treatment of water pollution, etc.

2. Additional nonproductive space requirements for which there are no financial criteria. Examples: office space, laboratories, service areas (kitchens, restrooms, etc.).

b. Quality: Projects designed primarily to improve quality. c. Increase Profit:

1. Projects that are justified primarily by reduced costs.

2. Projects that are designed primarily to increase production capacity for an existing product.

3. Projects designed to provide facilities to manufacture and distribute a new product or product line.

d. Other: This category includes projects which by definition are excluded from the three preceding categories. Examples: standby facilities intended to insure uninterrupted production, additional equipment not expected to improve profits or product quality and not required for reasons of safety and convenience, equipment to satisfy marketing requirements, etc.

Payback and ROFE Criteria Payback—return on funds projections not required but the request must clearly demonstrate the immediate need for the project and the lack or inadequacy of alternative solutions. Requests for nonproductive facilities, such as warehouses, laboratories, and offices should indicate the advantages of owning rather than leasing, unless no possibility to lease exists. In those cases where the company owns a group of integrated facilities and wherein the introduction of rented or leased properties might complicate the long-range planning or development of the area, owning rather than leasing is recommended. If the project is designed to improve customer service (such as market-centered warehouses) this factor is to be noted on the project request. If Payback and ROFE cannot be computed, it must be clearly demonstrated that the improvement is identifiable and desirable. Projects with a Payback period up to 10 years and a 10-year return on funds as low as 20% PBT are considered worthy of consideration, provided (1) the end product involved is believed to be a reasonably permanent part of our line or (2) the facilities involved are so flexible that they may be usable for successor products. Projects for a proven product where the risk of mortality is small, such as coffee, Jell-O Gelatin, and cereals, should assure a payback in no more than 10 years and 10-year PBT return on funds of no less than 20%. Because of the greater risk involved, such projects should show a high potential return on funds (not less than a 10-year PBT return of 40%). Payback period, however, might be as much as 10 years because of losses incurred during the market development period.a

While standards of return may be difficult to set, some calculations of financial benefits should be made where possible.

Source: The General Foods Accounting and Financial Manual.

aThese criteria apply to the United States and Canada only. Profit-increasing capital projects in other areas in categories c1 and c2 should offer at least a 10-year PBT return of 24% to compensate for the greater risk involved. Likewise, foreign operation projects in the c3 category should offer a 10-year PBT return of at least 48%.

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The Super Project 112-034

7

Exhibit 5 Capital Project Request Form of General Foods Corporation

NY1292-A 12-63 PTD. In U.S.A.

“Super” Facilities 66-42 Project Title & Number Jell-O Division — St. Louis Division & Location x

December 23, 1966 Date

Expansion-New Product A

R

Purpose

New Request Supplementx

x

Project Description Summary of Investment To provide facilities for production New Capital Funds Required $200M of Super, chocolate dessert. This Expense Before Taxes – – project included finishing a packing room in addition to filling and

Less: Trade-in or Salvage, If Any – –

packaging equipment. Total This Request $200M Previously Appropriated – –

Total Project Cost $200M

Financial Justification ROFE (PBT Basis) – 10 Yr. Average 62.9 Payback

Period April, F’68 Feb, F’75 From To

6.83 Yrs.

Not Required

* Based on Total Project Cost and Working Fund of

$510M

Estimated Expenditure Rate Quarter Ending Mar. F19 67 $160M Quarter Ending June F19 68 40M Quarter Ending F19 Quarter Ending F 19 Remainder

Other Information

Major Specific Blanket Ordinary

Included in Annual program Yes No

Per cent of Engineering Completed 80% Estimated Start-Up Cost $15M Estimated Start-Up Date April

Level of Approval Required

Board Chairman Exec. V.P. Gen. Mgr.

For Division Use—Signatures Signatures Name & Title Date Director Corp. Eng. Date

Director B&A General Manager Exec. Vice President President Chairman

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112-034 The Super Project

8

Exhibit 5 (continued) Instructions for Capital Project Request Form NY 1292-A

The purpose of this form is to secure management’s authorization to commit or expend funds on a capital project. Refer to Accounting and Financial Manual Statement No. 19 for information regarding projects to which this form applies.

New Request—Supplement Check the appropriate box.

Purpose Identify the primary purpose of the project in accordance with the classifications established in Accounting and Financial Statement No. 19, i.e., Sanitation, Health and Public Convenience, Nonproductive Space, Safety, Quality, Reduce Cost, Expansion—Existing Products, Expansion—New Products, Other (specify). Also indicate in the appropriate box whether the equipment represents an addition or a replacement.

Project Description Comments should be in sufficient detail to enable Corporate Management to appraise the benefits of the project. Where necessary, supplemental data should be attached to provide complete background for project evaluation.

Summary of Investment

New Capital Funds Required Show gross cost of assets to be acquired.

Expense Before Taxes Show incremental expense resulting from project.

Trade-in or Salvage Show the amount expected to be realized on trade-in or sale of a replaced asset.

Previously Appropriated When requesting a supplement to an approved project, show the amount previously appropriated even though authorization was given in a prior year.

Financial Justification

ROFE Show the return on funds employed (PBT basis) as calculated on Financial Evaluation Form NY 1292-C or 1292-F. The appropriate Financial Evaluation Form is to be attached to this form.

Not Required Where financial benefits are not applicable or required or are not expected, check the box provided. The nonfinancial benefits should be explained in the comments.

In the space provided, show the sum of the Total Project Cost plus Total Working Funds (line 20, Form NY 1292-C or line 5, Form NY 1292-F) in either of the first three periods, whichever is higher.

Estimated Expenditure Rate Expenditures are to be reported in accordance with accounting treatment of the asset and related expense portion of the project. Insert estimated quarterly expenditures beginning with the quarter in which the first expenditure will be made. The balance of authorized funds unspent after the fourth quarter should be reported in total.

Other Information Check whether the project is a major, specific ordinary, or blanket, and whether or not the project was included in the Annual Program. Show estimated percentage of engineering completed; this is intended to give management an indication of the degree of reliability of the funds requested. Indicate the estimated start-up costs as shown on line 32 of Financial Evaluation Form NY 1292-C. Insert anticipated start-up date for the project; if start-up is to be staggered, explain in the comments.

Level of Approval Required Check the appropriate box.

Source: General Foods

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112-034 -9-

Exhibit 6 Financial Evaluation Form of General Foods Corporation ($ in thousands)

NY 1292-C 10-64 PTD. In U.S.A.

____________________ Date

Jell-O Division

St. Louis Location

The Super Project Project Title

67-89 Project No.

____________________ Supplement No.

Project Request Detail 1st Per. 2nd Per. ___ Per. ___ Per. ___ Per. Return on New Funds Employed—10-Yr. Avg. 1. Land $ PAT (C ÷ A) PBT (B ÷ A) 2. Buildings 80 A – New Funds Employed (Line 21) $380 $380 3. Machinery & Equipment 120 B – Profit Before Taxes (Line 35) $239 4. Engineering C – Net Profit (Line 37) $115 5. Other (Explain) D – Calculated Return 30.2% 62.0% 6. Expense Portion (Before Tax) 7. Sub Total $200 PayBack Years From Operational Date 8. Less: Salvage Value (Old Asset) Part Year Calculation for First Period – Yrs. 9. Total Project Cost* $200 Number of Full Years to Pay Back 6.00 Yrs. 10. Less: Taxes on Exp. Portion Part Year Calculation for Last Period 0.83 Yrs. 11. Net Project Cost $200 Total Years to Pay Back 6.83 Yrs. *Same as Project Request Funds Employed

1st Per.

F 68

2nd Per.

F 69

3rd Per.

F 70

4th Per.

F 71

5th Per.

F 72

6th Per.

F 73

7th Per.

F 74

8th Per.

F 75

9th Per.

F 76

10th Per.

F 77

11th. Per.

_____

10-Yr. Avg.

12. Net Project Cost (Line 11) $200 200 200 200 200 200 200 200 200 200 13. Deduct Depreciation (Cum.) 19 37 54 70 85 98 110 121 131 140 14. Capital Funds Employed $181 163 146 130 115 102 90 79 69 60 113 15. Cash 16. Receivables 124 134 142 157 160 160 169 169 178 178 157 17. Inventories 207 222 237 251 266 266 281 281 296 296 260 18. Prepaid & Deferred Exp. 19. Less Current Liabilities (2) (82) (108) (138) (185) (184) (195) (195) (207) (207) (150) 20. Total Working Funds (15 Thru 19) 329 274 271 264 241 242 255 255 267 267 267 21. Total New Funds Employed (14 + 20) $510 437 417 394 356 344 345 334 336 327 380

Profit And Loss 22. Unit Volume (in thousands) 1100 1200 1300 1400 1500 1500 1600 1600 1700 1700 1460 23. Gross Sales $2200 2400 2600 2800 3000 3000 3200 3200 3400 3400 2920 24. Deductions 88 96 104 112 120 120 128 128 136 136 117 25. Net Sales 2112 2304 2496 2688 2880 2880 3072 3072 3264 3264 2803 26. Cost of Goods Sold 1100 1200 1300 1400 1500 1500 1600 1600 1700 1700 1460 27. Gross Profit 1012 1104 1196 1288 1380 1380 1472 1472 1564 1564 1343 Gross Profit % Net Sales 28. Advertising Expense 29. Selling Expense 30. Gen. and Admin. Cost 31. Research Expense 32. Start-Up Costs 33. Other (Explain) Test Mkt. 34. Adjustments (Explain) Erosion

1100

15 360 180

1050

200

1000

210

900

220

700

230

700

230

730

240

730

240

750

250

750

250

841

2 36

225 35. Profit Before Taxes $(643) (146) (14) 168 450 450 502 502 564 564 239 36. Taxes (334) (76) (7) 87 234 234 261 261 293 293 125 36A. Add: Investment Credit (1) (1) (1) (1) (1) (1) (1) (1) – – (1) 37. Net Profit (308) (69) (6) 82 217 217 242 242 271 271 115 38. Cumulative Net Profit $(308) (377) (383) (301) (84) 133 375 617 888 1159 39. New Funds to Repay (21 Less 38) $818 814 800 695 440 211 (30) (283) (552) (832)

See Accounting & Financial Manual Policy No. 19 for Instructions.

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112-034 The Super Project

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Exhibit 6 (continued) Instructions for Preparation of Form NY 1292-C Financial Evaluation

This form is to be submitted to Corporate Budget and Analysis with each profit-increasing capital project request requiring $50,000 or more of capital funds and expense before taxes.

Note that the 10-year term has been divided into 11 periods. The first period is to end on the March 31 following the operational date of the project, and the P&L projection may thereby encompass any number of months from 1 to 12, e.g., if the project becomes operational on November 1, 1964, the first period for P&L purposes would be 5 months (November 1, 1964 through March 31, 1965). The next nine periods would be fiscal years (F ‘66, F ‘67, etc.) and the 11th period would be 7 months (April 1, 1974 through October 30, 1974). This has been done primarily to facilitate reporting of projected and actual P&L data by providing for fiscal years. See categorized instructions below for more specific details.

Project Request Detail Lines 1 through 11 show the breakdown of the Net Project Cost to be used in the financial evaluation. Line 8 is to show the amount expected to be realized on trade-in or sale of a replaced asset. Line 9 should be the same as the “Total Project Cost” shown on Form NY 1292-A, Capital Project Request. Space has been provided for capital expenditures related to this project which are projected to take place subsequent to the first period. Indicate in such space the additional cost only; do not accumulate them.

Funds Employed

Capital Funds Employed Line 12 will show the net project cost appearing on line 11 as a constant for the first 10 periods except in any period in which additional expenditures are incurred; in that event show the accumulated amount of line 11 in such period and in all future periods.

Deduct cumulative depreciation on Line 13. Depreciation is to be computed on an incremental basis, i.e., the net increase in depreciation over present depreciation on assets being replaced. In the first period depreciation will be computed at one half of the first year’s annual rate; no depreciation is to be taken in the 11th period. Depreciation rates are to be the same as those used for accounting purposes. Exception: When the depreciation rate used for accounting purposes differs materially from the rate for tax purposes, the higher rate should be used. A variation will be considered material when the first full year’s depreciation on a book basis varies 20% or more from the first full year’s depreciation on a tax basis.

The 10-year average of Capital Funds Employed shall be computed by adding line 14 in each of the first 10 periods and then dividing the total by 10.

Total Working Funds Refer to Financial Policy No. 21 as a guide in computing new working fund requirements. Items which are not on a formula basis and which are normally computed on a five-quarter average shall be handled proportionately in the first period. For example, since the period involved may be less than 12 months, the average would be computed on the number of quarters involved. Generally, the balances should be approximately the same as they would be if the first period were a full year.

Cash, based on a formula which theorizes a two weeks’ supply (2/52nds), should follow the same theory. If the first period is for three months, two-thirteenths (2/13th) should be used; if it is for five months, two-twenty-firsts (2/21sts) should be used, and so forth.

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The Super Project 112-034

11

Exhibit 6 (continued)

Current liabilities are to include one-half of the tax expense as the tax liability. The 10-year averages of Working Funds shall be computed by adding each line across or the first 10 periods and then dividing each total by 10.

Profit and Loss Projection

P&L Categories (Lines 22 through 37) Reflect only the incremental amounts which will result from the proposed project; exclude all allocated charges. Include the P&L results expected in the individual periods comprising the first 10 years of the life of the project. Refer to the second paragraph of these instructions regarding the fractional years’ calculations during the first and eleventh periods.

Any loss or gain on the sale of a replaced asset (see line 8) shall be included on line 33.

As indicated in the caption Capital Funds Employed, no depreciation is to be taken in the eleventh period.

The 10-year averages of the P&L items shall be computed by adding each line across for the 11 periods (10 full years from the operational date) and dividing the total by 10.

Adjustments (Line 34) Show the adjustment necessary, on a before-tax basis, to indicate any adverse or favorable incremental effect the proposed project will have on any other products currently being produced by the corporation.

Investment Credit To be included on line 36-A. The Investment Credit will be spread over 8 years, or fractions thereof, as an addition to PAT.

Return on New Funds Employed Ten-year average returns are to be calculated for PAT (projects requiring Board approval only) and PBT. The PAT return is calculated by dividing average PAT (line 37) by average new funds employed (line 21); the PBT return is derived by dividing average PBT (line 35) by average new funds employed (line 21).

Payback Years From Operational Date

Part Year Calculation for First Period Divide number of months in the first period by 12. If five months are involved, the calculation is 5/12 = 0.4 years.

Number of Full Years to Payback Determined by the last period, excluding the first period, in which an amount is shown on line 39.

Part Year Calculation for Last Period Divide amount still to be repaid at the end of the last full period (line 39) by net profit plus the annual depreciation in the following year when payback is completed.

Total Years to Payback Sum of full and part years.

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112-034 The Super Project

12

Appendix A Memos to Controller

To: J. C. Kresslin, Corporate Controller

From: J. E. Hooting, Director, Corporate Budgets and Analysis

March 2, 1967

Super Project

At the time we reviewed the Super project, I indicated to you that the return on investment looked significantly different if an allocation of the agglomerator and building, originally justified as a Jell-O project, were included in the Super investment. The pro rata allocation of these facilities, based on the share of capacity used, triples the initial gross investment in Super facilities from $200,000 to about $672,000.

I am forwarding a memorandum from Crosby Sanberg summarizing the results of three analyses evaluating the project on an:

I. Incremental basis

II. Facilities-used basis

III. Fully allocated facilities and costs basis

Crosby has calculated a 10-year average ROFE using these techniques. Please read Crosby’s memo before continuing with my note.

* * * * *

Crosby concludes that the fully allocated basis, or some variation of it, is necessary to understand the long-range potential of the project.

I agree. We launch a new project because of its potential to increase our sales and earning power for many years into the future. We must be mindful of short-term consequences, as indicated by an incremental analysis, but we must also have a long-range frame of reference if we are to really understand what we are committing ourselves to. This long-range frame of reference is best approximated by looking at fully allocated investment and “accounted” profits, which recognize fully allocated costs because, in fact, over the long run all costs are variable unless some major change occurs in the structure of the business.

Our current GF preoccupation with only the incremental costs and investment causes some real anomalies that confuse our decision making. Super is a good example. On an incremental basis the project looks particularly attractive because by using a share of the excess capacity built on the coattails of the lucrative Jell-O project, the incremental investment in Super is low. If the excess Jell-O capacity did not exist, would the project be any less attractive? In the short term, perhaps yes because it would entail higher initial risk, but in the long term it is not a better project just because it fits a facility that is temporarily unused.

Looking at this point from a different angle, if the project exceeded our investment hurdle rate on a short-term basis but fell below it on a long-term basis (and Super comes close to doing this), should we reject the project? I say yes because over the long run, as “fixed” costs become variable and as we have to commit new capital to support the business, the continuing ROFE will go under water.

In sum, we have to look at new project proposals from both the long-range and the short-term point of view. We plan to refine our techniques of using a fully allocated basis as a long-term point of reference and will hammer out a policy recommendation for your consideration. We would appreciate any comments you may have.

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The Super Project 112-034

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Appendix A (continued) Memos to Controller

To: J. E. Hooting, Director, Corporate Budgets and Analysis

From: C. Sanberg, Manager, Financial Analysis

February 17, 1967

Super Project: A Case Example of Investment Evaluation Techniques

This will review the merits of alternative techniques of evaluating capital investment decisions using the Super project as an example. The purpose of the review is to provide an illustration of the problems and limitations inherent in using incremental ROFE and payback and thereby provide a rationale for adopting new techniques.

Alternative Techniques

The alternative techniques to be reviewed are differentiated by the level of revenue and investment charged to the Super project in figuring a payback and ROFE, starting with incremental revenues and investment. Data related to the alternative techniques outlined below are summarized [at the end of this memo].

Alternative I. Incremental Basis

Method The Super project as originally evaluated considered only incremental revenue and investment, which could be directly identified with the decision to produce Super. Incremental fixed capital ($200M) basically included packaging equipment.

Result On this basis the project paid back in 7 years with a ROFE of 63%.

Discussion Although it is General Foods’ current policy to evaluate capital projects on an incremental basis, this technique does not apply to the Super project. The reason is that Super extensively utilizes existing facilities, which are readily adaptable to known future alternative uses.

Super should be charged with the ‘opportunity loss’ of agglomerating capacity and building space. Because of Super the opportunity is lost to use a portion of agglomerating capacity for Jell-O and other products that could potentially be agglomerated. In addition, the opportunity is lost to use the building space for existing or new product volume expansion. To the extent there is an opportunity loss of existing facilities, new facilities must be built to accommodate future expansion. In other words, because the business is expanding Super utilizes facilities that are adaptable to predictable alternative uses.

Alternative II. Facilities-Used Basis

Method Recognizing that Super will use half of an existing agglomerator and two-thirds of an existing building, which were justified earlier in the Jell-O project, we added Super’s pro rata share of these facilities ($453M) to the incremental capital. Overhead costs directly related to these existing facilities were also subtracted from incremental revenue on a shared basis.

Result ROFE 34%

For the exclusive use of B. Marlin, 2017.

This document is authorized for use only by Bobby Marlin in Spring 2017 FIN 4596-1 taught by Amir Shoham, Temple University from January 2017 to June 2017.

112-034 The Super Project

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Discussion Although the existing facilities utilized by Super are not incremental to this project, they are relevant to the evaluation of the project because potentially they can be put to alternative uses. Despite a high return on an incremental basis, if the ROFE on a project was unattractive after consideration of the shared use of existing facilities, the project would be questionable. Under these circumstances, we might look for a more profitable product for the facilities.

In summary, the facilities-used basis is a useful way of putting various projects on a common ground for purposes of relative evaluation. One product using existing capacity should not necessarily be judged to be more attractive than another practically identical product which necessitates an investment in additional facilities.

Alternative III. Fully Allocated Basis

Method Further recognizing that individual decisions to expand inevitably add to a higher overhead base, we increased the costs and investment base developed in Alternative II by a provision for overhead expenses and overhead capital. These increases were made in year five of the 10-year evaluation period, on the theory that at this point a number of decisions would result in more fixed costs and facilities. Overhead expenses included manufacturing costs, plus selling and general and administrative costs on a per unit basis equivalent to Jell-O. Overhead capital included a share of the distribution system assets ($40M).

Result ROFE 25%

Discussion Charging Super with an overhead burden recognizes that overhead costs in the long run increase in proportion to the level of business activity, even though decisions to spend more overhead dollars are made separately from decisions to increase volume and provide the incremental facilities to support the higher volume level. To illustrate, the Division-F1968 Financial Plan budgets about a 75% increase in headquarters’ overhead spending in F1968 over F1964. A contributing factor was the decision to increase the sales force by 50% to meet the demands of a growing and increasingly complex business. To further illustrate, about half the capital projects in the F1968 three-year Financial Plan are in the ‘non- payback’ category. This group of projects comprised largely ‘overhead facilities’ (warehouses, utilities, etc.), which are not directly related to the manufacture of products but are necessary components of the total business activity as a result of the cumulative effect of many decisions taken in the past.

The Super project is a significant decision which will most likely add to more overhead dollars as illustrated above. Super volume doubles the powdered dessert business category; it increases the Division businesses by 10%. Furthermore, Super requires a new production technology: agglomeration and packaging on a high-speed line.

Conclusions

1. The incremental basis for evaluating a project is an inadequate measure of a project’s worth when existing facilities with a known future use will be utilized extensively.

2. A fully allocated basis of reviewing major new product proposals recognizes that overheads increase in proportion to the size and complexity of the business and provides the best long-range projection of the financial consequences.

For the exclusive use of B. Marlin, 2017.

This document is authorized for use only by Bobby Marlin in Spring 2017 FIN 4596-1 taught by Amir Shoham, Temple University from January 2017 to June 2017.

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Alternative Evaluations of Super Project ($ in thousands)

I. Incremental

Basis

II. Facilties-Used

Basis

III. Fully

Allocated

Investment Working capital $267 $267 $267

Fixed capital

Gross 200 653 672

Net 113 358 367

Total net investment 380 625 634

Profit before taxesa

239 211 157

ROFE

63% 34% 25%

Jell-O project Building $200 x 2/3 = $133 Agglomerator 640 x 1/2 = 320

$453

Note: Figures based on 10-year averages.

aAssumes 20% of Super volume will replace existing Jell-O business.

For the exclusive use of B. Marlin, 2017.

This document is authorized for use only by Bobby Marlin in Spring 2017 FIN 4596-1 taught by Amir Shoham, Temple University from January 2017 to June 2017.

112-034 The Super Project

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Appendix B Controller’s Reply

To: Mr. J. F. Hooting, Director, Corporate Budgets and Analysis

From: Mr. J. C. Kresslin, Corporate Controller

Subject: Super Project

March 7, 1967

On March 2 you sent me a note describing Crosby Sanberg’s and your thoughts about evaluating the

Super project. In this memo you suggest that the project should be appraised on the basis of fully allocated facilities and production costs.

In order to continue the dialogue, I am raising a couple of questions below.

It seems to me that in a situation such as you describe for Super, the real question is a management decision as to whether to go ahead with the Super project or not go ahead. Or to put it another way, are we better off in the aggregate if we use half the agglomerator and two-thirds of an existing building for Super, or are we not, on the basis of our current knowledge?

It might be assumed that, for example, half of the agglomerator is being used and half is not and that a minimum economical size agglomerator was necessary for Jell-O and, consequently, should be justified by the Jell-O project itself. If we find a way to utilize it sooner by producing Super on it, aren’t we better off in the aggregate, and the different ROFE figure for the Super project by itself becomes somewhat irrelevant? A similar point of view might be applied to the portion of the building. Or if we charge the Super project with half an agglomerator and two-thirds of an existing building, should we then go back and relieve the Jell-O projects of these costs in evaluating the management’s original proposal?

To put it another way, since we are faced with making decisions at a certain time on the basis of what we then know, I see very little value in looking at the Super project all by itself. Better we should look at the total situation before and after to see how we fare.

As to allocated production costs, the point is not so clear. Undoubtedly, over the long haul, the selling prices will need to be determined on the basis of a satisfactory margin over fully allocated costs. Perhaps this should be an additional requirement in the course of evaluating capital projects, since we seem to have been surprised at the low margins for “Tasty” after allocating all costs to the product.

I look forward to discussing this subject with you and with Crosby at some length.

For the exclusive use of B. Marlin, 2017.

This document is authorized for use only by Bobby Marlin in Spring 2017 FIN 4596-1 taught by Amir Shoham, Temple University from January 2017 to June 2017.

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