Asked by Ogheneruno Siakpebru on Apr 26, 2024
Verified
Which of the following statements best describes externalities?
A) An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favourable effect on other operations, then this is not an externality.
B) An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline.
C) The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favour the NPV.
D) Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
Externalities
Costs or benefits that affect parties who did not choose to incur that cost or benefit, often related to environmental, public health, or economic activities.
Net Present Value (NPV)
A calculation used to assess the profitability of an investment, measuring the difference between the present value of its cash inflows and outflows.
Internal Rate of Return (IRR)
The rate of growth a project is expected to generate, calculated as the discount rate that makes the net present value (NPV) of all cash flows equal to zero.
- Gain insight into the importance of externalities and their impact on project valuation.
Verified Answer
JM
Julia MuralovaApr 28, 2024
Final Answer :
B
Explanation :
Externalities refer to the positive or negative impact that a project or decision may have on parties not directly involved in that project or decision. The example of a new bank office causing deposits in other offices to decline illustrates a negative externality as it negatively affects parties not directly involved in the decision to open the new office. Option B correctly describes this concept. Options A, C, and D do not accurately describe externalities.
Learning Objectives
- Gain insight into the importance of externalities and their impact on project valuation.