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