Relevant vs Irrelevant Cash Flows: The Capital Budgeting Filter

Interactive quiz from Lecture 13: Capital Budgeting Introduction

The Golden Rule: Include only cash flows that occur ONLY IF the project is undertaken. Ask: "Would this cash flow happen if we don't do the project?" If yes, it's irrelevant.
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Answer the scenarios below to test your understanding

Scenario Quiz

Summary: Include vs Exclude

Category Decision Key Reason
Sunk Costs
(already spent)		 EXCLUDE Cash already left the company; irrelevant to future decisions
Overhead Allocations
(corporate overhead)		 EXCLUDE Would continue even if project dies; not incremental
Financing Costs
(interest, dividends)		 EXCLUDE Handled via discount rate; including them double-counts
Cash Unchanged
(by definition non-incremental)		 EXCLUDE Project does not change the cash flow
Opportunity Costs
(asset could be used/leased)		 INCLUDE Project prevents that alternative; opportunity is lost
Side Effects (Positive)
(synergies, increased sales)		 INCLUDE Incremental revenue caused by project
Side Effects (Negative)
(cannibalization)		 INCLUDE Lost sales on other products due to project (negative CF)
Working Capital
(NWC changes)		 INCLUDE Project requires investment in inventory, receivables, etc.
Capital Expenditures
(equipment purchase)		 INCLUDE Project requires the investment; only happens if project goes forward
Salvage Value
(asset sale at end)		 INCLUDE Terminal cash flow specific to this project
Tax Effects
(depreciation shields, gains/losses)		 INCLUDE Taxes are real cash flows; company pays less if project can depreciate