Question

Smith Incorporated makes Diapers and recently added washable diapers to its product line. When the company worked on its capital budgeting decision, how would they have incorporated the impact on its old product? What is this effect called?    

Answer 1

This effect is called Externalities. If the impact of externalities can be measured, they should be incorporated in the capital budgeting analysis. If the cost of the Externalities cannot be measured precisely as in this case - Most firms use subjective analysis of Externalities before making a project's final accept or reject decisson.

For example, If the NPV of this project is slightly greater than 0, company officials may reject the project if yhey believe significant unmeasured negative Externalities are present.