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.

Question

Quizplus · Accepted Answer

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.

Which of the Following Statements Best Describes Externalities