7. Discussion

This section has shown how to compute the incremental cash flows of investment projects. In particular, we have discussed the following situations that frequently arise in capital budgeting reality:

  

  • Synergies (positive or negative): We should assume a firm-wide perspective and incorporate all incremental cash flows into our project valuation. Thereby, positive synergies with other activities will increase the value of the project whereas negative synergies will lower it.
     
  • Opportunity costs of resources: We need to know what else the firm could do with the available resources. Generally speaking, we should charge the project the net benefits from the best alternative use of the resources in question as a cash outflow.
     
  • Overhead expenses: The valuation should only include incremental cash flows. If overhead expenses are not incremental, we should ignore them.
     
  • Transfer prices and consulting fees: The valuation should be based on actual market values. Transfer prices and consulting fees should only be included if they constitute such a market value. Otherwise, we should ignore them or replace them with actual market prices.
     
  • Sunk costs: This money is gone. If we cannot recover it with our project decision, it is irrelevant for today's decision and we should ignore sunk costs. Let bygones be bygone.