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would have a favorable 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 favor 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.
e. Identifying an externality can never lead to an increase in the
calculated NPV.
2. Taussig Technologies is considering two potential projects, X and Y.
In assessing the projects’ risks, the company estimated the beta of each
project versus both the company’s other assets and the stock market, and
it also conducted thorough scenario and simulation analyses. This
research produced the following data:
Project X
Expected NPV
Project Y
$350,000
Standard deviation (σNPV) $100,000
Project beta (vs. market) 1.4
$350,000
$150,000
0.8