3. Identifying incremental cash flows Aa Aa 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 project's financing costs Changes in net working capital associated with the project The project's fixed-asset expenditures The project's depreciation expense Indirect cash flows often affect a firm's 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 project's acceptance), but others should be ignored. are cash flows that the firm forgoes as a result of accepting the project under consideration. In general, these are cash flows of the next best alternative to the project. 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 column, indicate whether the item should be included in the project's analysis or not. Sunk Cost Opportunity Cost Change in NWC Include in the Analysis? Cannibalization The new project is likely to have a negative impact on the company's 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 firm's interest expense will increase by $700,000. Should the change in interest expense be included in the analysis? Yes No