I want an Excutive Summary for this case. Thanks.

The Super Project In March 1967, Crosby Sanberg, a financial analysis manager at General Foods Corporation, told acase writer, "What I learned about incremental analysis at the Business School doesn't alwayswork." He was convinced that under some circumstances sunk costs were relevant to capitalproject evaluations. He was also concerned that financial and accounting systems did not providean accurate estimate of incremental costs and revenues, and that this was one of the most difficultproblems in measuring the value of capital investment proposals. Mr. Sanberg used the Super project as an example. 1 Super was a new instant dessert, based on a flavored, water-soluble, agglomerated powder. 2 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 operationsunder 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 buildingmodifications and $120,000 for machinery and equipment. Modifications would be made to anexisting building, where Jell-O was manufactured. Since available capacity of a Jell-Oagglomerator would be used in the manufacture of Super, no cost for the key machine wasincluded in the project. The $120,000 machinery and equipment item represented packagingmachinery. The Market A Nielsen survey indicated that powdered desserts constituted a significant and growing segmentof the total dessert market, as shown in Table A (next page). On the basis of test marketexperience, 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-runrequirements. Filling and packaging equipment to be purchased had a capacity of 1.9 million unitson a two-shift, five-day workweek basis. This represented considerable excess capacity, since1968 requirements were expected to reach 1.1 million units, and the national potential was 1 The name and nature of this new product have been disguised to avoid the disclosure of confidential information. 2 Agglomeration is a process by which the processed powder is passed through a steam bath andthen dried. This fluffs up the powder particles and increases solubility. 1-209dfc44e3.png1-209dfc44e3.png1-209dfc44e3.png regarded as 1.6 million units. However, the extra capacity resulted from purchasing standardequipment, and a more economical alternative did not exist. TABLE ADessert Market, August-September 1966 Compared with August-September 1965 Market Share Change from Aug.-Sept.1965 Desserts Aug.-Sept. 1966 Share Points Volume (%) Jell-O ................................................... 19.0% 3.6 40.0Tasty..................................................... 4.0 4.0 (new)Total powders.................................. 25.3 7.6 62.0Pie fillings and cake mixes ................. 32.0 3.9 (no change)Ice cream ............................................. 42.7 3.4 5.0Total market.................................... 100.0% 13.0 Capital Budgeting Procedure The General Foods Accounting and Financial Manual identified four categories of capitalinvestment project proposals: (1) safety and convenience; (2) quality; (3) increased profit; and (4)other. Proposal procedures and criteria for accepting projects varied according to category (Exhibit4). In discussing these criteria, Mr. Sanberg noted that the payback and return guidelines were notused as cutoff measures and added: Payback and return on investment are rarely the only measures of acceptability.Criteria vary significantly by type of project. A relatively high return might berequired for a new product in a new business category. On the other hand, amuch lower return might be acceptable for a new product entry whichrepresented 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 pay back and return onfunds employed were required for each such project requiring $50,000 or more of new capitalfunds and expense before taxes. The payback period was the length of time required for theproject to repay the investment from the date the project became operational. In calculating therepayment 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 taxesby the 10-year average funds employed. Funds employed included incremental net fixed assetsplus or minus related working capital. Start-up costs and any profits or losses incurred before theproject became operational were included in the first profit and loss period in the financialevaluation calculation. 2-ac62430720.png2-ac62430720.png2-ac62430720.png2-ac62430720.png Capital Budgeting Atmosphere A General Foods accounting executive commented on the atmosphere within which capitalprojects were reviewed: Our problem is not one of capital rationing. Our problem is to find enough goodsolid 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 of capital investments is usually an increase in thecapital 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 canafford 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 eightdivisions into a balanced company plan which meets our overall growthobjectives. 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 summaryappropriation request prepared to justify the project to management and to secure management'sauthorization to expend funds on a capital project. Exhibit 6 presents the backup detail. Cost of themarket test was included as "Other" expense in the first period, because a new product had to payfor its test market expense, even though this might be a sunk cost at the time capital funds wererequested. The "Adjustments" item represented erosion of the Jell-O market and was calculated bymultiplying the volume of erosion times a variable profit contribution. In the preparation of thisfinancial evaluation form, costs of acquiring packaging machinery were included, but no cost wasattributed to Jell-O agglomerator capacity to be used for the Super project, because the GeneralFoods Accounting and Financial Manual specified that capital project requests be prepared on anincremental basis: The incremental concept requires that project requests, profit projections,and funds-employed statements include only items of income and expenseand investment in assets which will be realized, incurred, or made directlyas 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, Mr. Sanberg studied the situation and wrote amemorandum arguing that the incremental approach advocated by the manual should not beapplied to the Super project. His superior agreed with the memorandum and forwarded it to thecorporate controller with the covering note contained in Appendix A. The controller's reply is givenin Appendix B. Appendix AMemos to Controller To: J. C. Kresslin, Corporate Controller From: J. E. Hooting, Director, Corporate Budgets and AnalysisMarch 2, 1967Super ProjectAt the time we reviewed the Super project, I indicated to you that the return oninvestment 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 theinitial 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 an1. Incremental basis2. Facilities-used basis3. Fully allocated facilities and costs basisCrosby has calculated a 10-year average ROFE using these techniques. Pleaseread Crosby's memo before continuing with my note. * * * Crosby concludes that the fully allocated basis, or some variation of it, isnecessary to understand the long-range potential of the project.I agree. We launch a new project because of its potential to increase our sales andearning power for many years into the future. We must be mindful of short-termconsequences, 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 ourselvesto. This long-range frame of reference is best approximated by looking at, fully allocatedinvestment and "accounted" profits, which recognize fully allocated costs, because infact, over the long run all costs are variable unless some major change occurs in thestructure of the business.Our current GF preoccupation with only the incremental costs and investmentcauses 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 shareof the excess capacity built on the coattails of the lucrative Jell-O project, the incrementalinvestment in Super is low. If the excess Jell-O capacity did not exist, would the project 4-e3a98afa14.jpg RESTRICTED INTERNAL USE ONLY(super project: p. 5 of 16 pages) be any less attractive? In the short term, perhaps yes because it would entail higher initialrisk; but in the long term, it is not a better project just because it fits a facility that istemporarily 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 (andSuper comes close to doing this), should we reject the project? I say yes, because over thelong run, as "fixed" costs become variable and as we have to commit new capital tosupport the business, the continuing ROFE will go under water.In sum, we have to look at new project proposals from both the long-range andthe 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.To: J. E. Hooting, Director, Corporate Budgets and AnalysisFrom: C. Sanberg, Manager, Financial AnalysisFebruary 17, 1967 Super Project: A Case Example of InvestmentEvaluation Techniques This will review the merits of alternative techniques of evaluating capitalinvestment decisions using the Super project as an example. The purpose of the review isto provide an illustration of the problems and limitations inherent in using incrementalROFE 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 alternativetechniques are summarized at the end of this memo. Alternative 1. Incremental BasisMethod. The Super project as originally evaluated considered only incremental revenueand 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%. 5-c28423eb41.jpg RESTRICTED INTERNAL USE ONLY(super project: p. 6 of 16 pages) Discussion. Although it is General Foods' current policy to evaluate capital projects onan incremental basis, this technique does not apply to the Super project. The reason isthat Super extensively utilizes existing facilities, which are readily adaptable to knownfuture alternative uses.Super should be charged with the "opportunity loss" of agglomerating capacityand 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 beagglomerated. 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 existingfacilities, 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 2. Facilities-Used BasisMethod. Recognizing that Super will use half of an existing agglomerator and two thirdsof an existing building, which were justified earlier in the Jell-O project, we addedSuper's pro rata share of these facilities ($453M) to the incremental capital. Overheadcosts directly related to these existing facilities were also subtracted from incrementalrevenue on a shared basis. Result. A ROFE of 34% results. 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 were 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 or putting various projects ona common ground for purposes of relative evaluation. One product using existingcapacity should not necessarily be judged to be more attractive than another practicallyidentical product that necessitates an investment in additional facilities. Alternative 3. Fully Allocated BasisMethod. Further recognizing that individual decisions to expand inevitably add to ahigher overhead base, we increased the costs and investment base developed inAlternative 2 by a provision for overhead expenses and overhead capital. These increaseswere made in year 5 of the 10-year evaluation period, on the theory that, at this point, anumber of decisions would result in more fixed costs and facilities. Overhead expensesincluded 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)