Question

How does opportunity costs and side effects affect capital budgeting decisions.

Answer 1

Opportunity cost is an inherent part of capital budgeting decision making process because opportunity cost means the benefit of best alternative which has been given up in order to accept the project. So it is the benefit of the best alternative which which was forgone in order of acceptance of the specific project. the benefit associated with the specific project must be more than the benefit which was forgone in order to undertake the specific project.

Side effects is a way a project can impact other projects of the company. It is important to include the impact of side effect into the capital budgeting analysis.

When the new projects negatively impact the current cash flows of the firm, it can be said to be EROSION. Simultaneously new products can also add positive side effect the firm by value addition.