What is an incremental cash flow? What is a sunk cost? Why must you account for opportunity costs?

Question

What will be an ideal response?

Answer 1

An incremental cash flow is a free cash flows the company as a whole will receive if the company takes on a given
project. Therefore, a guiding rule in deciding if a free cash flow is incremental is to look at the company with, versus
without, the new project. In determining the free cash flows associated with the proposed project, we should consider
only the incremental sales brought to the company as a whole. Just moving sales from one product line to a new
product line does not bring anything new into the company. But if sales are captured from competitors or if sales that
would have been lost to new competing products are retained, then these are relevant incremental free cash flows.
Cash flows that have already taken place are often referred to as "sunk costs" because they have been sunk into the
project and cannot be recovered. As a rule, any cash flows that are not affected by the accept/reject criterion should not
be included in capital-budgeting analysis.
Finally, opportunity costs are cash flows that are lost because a given project consumes scarce resources that would
have produced cash flows if that project had been rejected. For example, a product consumes valuable floor space in a
production facility. The space could have been rented out. The key point is that opportunity-cost cash flows should
reflect the net cash flows that would have been received if the project under consideration had been rejected.