Capital allocation

Choosing among investments is choosing what not to do. This is the appraisal of individual proposals; which businesses and bets the company should be in belongs to corporate-strategy:portfolio-strategy.

Appraise on incremental cash

Only cash flows that change because of the decision belong in the analysis:

• Sunk costs are irrelevant. Money already spent is not a reason to continue, though it is reliably presented as one.
• Allocated overhead is usually irrelevant. If the cost occurs anyway, it does not belong in the incremental case.
• Opportunity cost is relevant, including the capacity consumed that then cannot serve anything else.
• Working capital is a real outflow. Growth that consumes cash is not free because it is growth.