When firms make capital budgeting decisions, they should concern themselves with incremental cash flows, not net income, when evaluating projects.

To determine the incremental cash flows associated with a capital project, an analyst should include all of the following except:

The projects depreciation expense

The projects financing costs

The projects fixed-asset expenditures

Changes in net working capital associated with the project

Indirect cash flows often affect a firms capital budgeting decisions. However, some of these indirect cash flows are relevant to capital budgeting decisions (because they represent marginal cash flows that depend on the projects acceptance), but others should be ignored.

is the cost the firm paid in the past and is unrecoverable. Accepting or rejecting a project will not change them, so they should not be included in capital budgeting analysis.

Consider the case of Bumbly Products Inc. The company is evaluating a capital budgeting project and has come across a few issues that require special attention.

Classify each item as a sunk cost, cannibalization, opportunity cost, or a change in net working capital (NWC). Then, in the last table, indicate whether the item should be included in the projects analysis or not.

	Sunk Cost	Opportunity Cost	Cannibalization	Change in NWC
The new project is expected to reduce sales revenue for one of the companys other product lines.
The project will use some equipment that the firm owns but isnt using currently. However, a used-equipment dealer has offered to buy the equipment.
Bumbly spent nearly $1.1 million in market research to develop new product ideas.
Many of the new sales from this project will be made on credit, causing accounts receivable to increase.
The factory that the project will use could be used for another project that is expected to have a slightly positive net present value (NPV).

	Include in the Analysis?
The new project is expected to reduce sales revenue for one of the companys other product lines.
The project will use some equipment that the firm owns but isnt using currently. However, a used-equipment dealer has offered to buy the equipment.
Bumbly spent nearly $1.1 million in market research to develop new product ideas.
Many of the new sales from this project will be made on credit, causing accounts receivable to increase.
The factory that the project will use could be used for another project that is expected to have a slightly positive net present value (NPV).

Suppose Bumbly will be issuing debt to support this project and other capital budgeting projects this year. The firms interest expense will increase by $700,000. Should the change in interest expense be included in the analysis?

Yes

No