Introduction to Finance

Cannibalization or Enhancement.
Cannibalization
occurs when a project robs cash 
fl ow from the fi rm’s existing lines of business. When a soft drink fi rm is thinking about intro-
ducing a new fl avor or a new diet product, the project’s incremental cash fl ows should consider 
how much the new off ering will erode the sales and cash fl ows of the fi rm’s other products. 
Corporate strategists reportedly considered how the introduction of Pepsi One, a new low-
calorie cola soft drink product, would aff ect sales of Diet Pepsi and Pepsi-Cola.
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Similarly, 
Intel engineers and strategists agonized for months before deciding it needed to design a new 
computer chip to advance the technology of one of its highly successful computer chips.
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On 
the other hand, Microsoft was slow to develop and introduce other products, which may have 
detracted from the success of its personal computer-based operating system software. Products 
that didn’t see the light day—or not until much later—include a tablet computer, a web-based 
Offi
ce product (in 2001), software for cars that allowed drivers to play digital music and hear 
email, and Offi
ce products that were compatible with Apple’s iPhone. The CEO at the time, 
Steven Ballmer, thought these projects cannibalized Microsoft’s main products and would 
have taken resources away from Offi
ce and Windows developments.
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Enhancement 
is less common than cannibalization; it is the increase in the cash fl ows 
of the fi rm’s other products that occur because of a new project. For example, adding a del-
icatessen to a grocery store may increase cash fl ows more than the deli sales alone if new deli 
customers also purchase grocery items.
Opportunity Costs.
From economics, we know that an 
opportunity cost
is the cost 
of passing up the next best alternative. For example, the opportunity cost of a building is its 
market value. By deciding to continue to own it, the fi rm is foregoing the cash it could receive 
from selling it. Economics teaches the TINSTAAFL principle: “there is no such thing as a free 
lunch.” Capital budgeting analysis frequently applies this principle to existing assets.