New capacity would have to be bought or built when capacity runs out or production would have to be cut back on one of the product lines, leading to a loss in cash flows that would have been generated by the lost sales runs. Thus, Blast would result in incremental cash flows for facilities and these should be included in cash outflow calculations. However, the case states that Blast will require only 10% of Lift-Off's plant capacity. Yet, Lift-Off has excess capacity of 45%. This indicates that Blast may not lead to the need to add capacity in the future. However, this is something that the Danforth & Donnalley executives should explore further with detailed market forecasts. The case states that Blast is very different from conventional powdered products and may well generate tremendous demand requiring more capacity in the 15 years of time considered.

In summary, even when considering present and future opportunity costs, Blast does not appear to lead to incremental cash flows for production facilities and the cost of the excess capacity should be considered free in this particular scenario.

3. Would you suggest that the cash flows resulting from erosion of sales from current laundry detergent products be included as a cash inflow? If there were chances of competition introducing a similar product if you do not introduce Blast, would this affect your answer?

Product cannibalization occurs when a new product introduced by a firm competes with and reduces sales of the firm's existing products. In this case, Blast is likely to cannibalize the sales of Lift-Off and Wave. Based on a strict capital budgeting interpretation, cash flows resulting from lost sales Lift-Off and Wave should not be included as a cash inflow because they are not incremental. In other words, if the project is not accepted, the cash flows will occur anyway.

However, the laundry detergent market is extraordinarily competitive and it seems prudent to assume that a competitor will introduce a product similar to Blast. Thus, the market erosion of Lift-Off and Wave is likely to...

Thus, if cash flows from sales erosion are not considered, this practice may result in the rejection of a project which would be acceptable to a competitor, resulting in the subsequent introduction of this product by competition. Hence, the sales erosion of the existing product lines may no longer be dependent upon the introduction of Blast. The firm now loses sales to a competitor rather than to itself.
In summary, the decision on whether or not treat cash flows resulting from erosion of sales from existing products depends on the ability and likelihood of Danforth & Donnalley's competition to introduce a similar product. If the business in which a firm operates is extremely competitive and there are no barriers to entry, as is the case with laundry detergent, the company should assume that the product cannibalization will occur anyway, and the costs associated with are not appropriate in an incremental cash flow analysis.

Unfortunately, the competitive impact on existing products is difficult to gauge. Market entry seems assured since Danforth & Donnalley do not mention barriers to entry such as patents or other technology advantages. However, brand name loyalty can also be a potential barrier to entry. Note, in the laundry detergent business brand loyalty is a very important factor. Firms with stronger brand name loyalty should therefore factor more of the cost of lost sales from existing products as a consequence of a new product introduction into their capital budgetng.

In addition, Danforth & Donnalley may believe that competitors will introduce an imperfect substitute which will lead to smaller erosion in existing product sales than Blast. Or perhaps the company believes that it may take competitors some period of time to introduce a product similar to Blast, meaning deferred erosion in the sales of Lift-Off and Wave. In this scenario, an intermediate solution, whereby Danforth & Donnalley consider some of the product cannibalization costs may be appropriate. A tremendous