Discuss in depth how opportunity cost, cannibalization, positive externalities, and sunk costs are instrumental in capital...

Discuss in depth how opportunity cost, cannibalization, positive externalities, and sunk costs are instrumental in capital budgeting decision making.

Expert Solution

Opportunity cost refers to the cost of losing the next best option. The opportunity cost must be taken into consideration in capital budgeting to understand and incorporate the cost of losing the other option.

Cannibalization refers to to the loss of cash flows due to selecting the option under consideration. Since it results in a loss of cash flows because of taking a particular decision it must be taken into account in capital budgeting.

An external it refers to the impact of the project on other things. While cannibalization is a negative externalities that can be positive externalities which impact the cash flows and hence must be taken into account during capital budgeting. For instance a new project may increase the revenues of another project which will increase the cash flows and hence must be considered during analysis.

Sunk cost refers to the cost that has been incurred earlier and which cannot be recovered by undertaking for rejecting the project. Hence this cost is sunk forever and has no impact on the capital budgeting decision.

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