Suppose the Innovative Motors Corporation (IMC) is determining the NPV of a new convertible sports car. Some of the would-be purchasers are owners of IMC’s compact sedans.

Are all cash flows from the new convertible sports car incremental?

The answer is no because some of the cash flow represents transfers from other elements of IMC’s product line. This is erosion, which must be included in the NPV calculation. Without taking erosion into account, IMC might erroneously calculate the NPV of the sports car to be, say, $100 million. If half the customers are transfers from the sedan and lost sedan sales have an NPV of −$150 million, the true NPV is − $50 million ( = $100 million − 150 million ) .

Synergy IMC is also contemplating the formation of a racing team. The team is forecast to lose money for the foreseeable future, with perhaps the best projection showing an NPV of −$35 million for the operation. However, IMC’s managers are aware that the team will likely generate great publicity for all of IMC’s products. A consultant estimates that the increase in cash flows elsewhere in the firm has a present value of $65 million. Assuming that the consultant’s estimates of synergy are accurate, the net present value of the team is $30 million ( = $65 million − 35 million ) . The company should form the team.