1. Cash Flow Estimation for Capital Budgeting
The Super Project
Cash Flow Estimation for Capital Budgeting

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

3. Test Market Expense Product Design R&D Market Testing Manufacturing
Investment
Working
Capital

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?

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?

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?

7. Assumptions and setup Exclude: Include: cash flow identity
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%

8. Cash Flow from Operations
Depreciation for Jell-O facilities: Sum-of-year digits; 40/15 year lives; $133/320

9. Cash Flows for Super
Investment tax credit of $8 in year 0; Tax shield on write-off of equip. in yr 11

10. DCF Calculation
NPV = $538 = accept

11. NPV Profile of Project
IRR = 18.5%

12. Sensitivity Analysis Use of Jell-O Facilities

13. Sensitivity Analysis Overhead

14. Sensitivity Analysis Erosion

15. NPV Sensitivity Analysis
OVERHEAD
JELLO FACILITIES
yes
(109)
EROSION
yes
(109) 20 no
yes
yes
208
(109)
208 no
337
538 no
yes
538
yes
538
538 no
667 no
yes
855
855 no
984 no