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 marginal taxes

The projects terminal value

The projects financing costs

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 likely to have a negative impact on the companys existing related products.
The project will use some raw materials that the firm has in its inventory and can sell at a certain price.
Bumbly invested in research and development to come up with this new product.
Most of the purchases for this project will be made using cash, causing cash in the company to decrease.
The project will use some equipment that the firm owns but isn't using currently. However, a used-equipment dealer has offered to buy the equipment.

	Include in the Analysis?
The new project is likely to have a negative impact on the companys existing related products.
The project will use some raw materials that the firm has in its inventory and can sell at a certain price.
Bumbly invested in research and development to come up with this new product.
Most of the purchases for this project will be made using cash, causing cash in the company to decrease.
The project will use some equipment that the firm owns but isn't using currently. However, a used-equipment dealer has offered to buy the equipment.

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