Question

Explain four problematic situations that will make determining incremental cash flows difficult.

Answer 1

Four Problematic Situation are
1. Cannibalisation: In this process the cash flows in one project might affect the cash flows in another project, if the products are substitute of each other or are closely related. The incremental cash flows might not increase to expected levels as the orojects might compete with each other.

2. Opportunity Cost: It is used in calculation of incremental cash flows.Opportunity cost is the cost of investing in the next best investment opportunity. If neglected a project might be wrong accepted or rejected due to miscalculation of the incremental cash flows.

3. Allocated Costs: Extra costs allocated to departments like office rents, resource costs,etc for a project is called allocated costs. These costs are usually not included hence there might be error in accepting or rejecting a project.

4. Sunk Costs: Costs that are incurred before project is undertaken. These costs are incurred whether the project is undertaken or not.Since only future cash flows are taken into account past sunk costs are not included in incremental cash flows.