Briefly explain why each of the following should or should not be considered in forecasting incremental cash flows from a project:
a. The cost of building a prototype of a new product to see if it was feasible.
b. Market research suggests that after buying a company's "smart phone" customers will begin to buy more of the same company's notebook computers.
c. A company decides to use existing space for storage. The company could have rented the space to another business for $2,500 a month.
Answer:
a. The cost of building the prototype is a sunk cost. It will not go away if the decision is not to go ahead with the new product, therefore it is not relevant to the decision.
b. If the company expects additional sales of an existing product as a result of introducing a new product, it should consider those sales as it forecasts incremental cash flows from the project.
c. The foregone rent is an example of opportunity cost. It is easier to forecast than most cash flows and should definitely be considered.
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