- CFA Exams
- CFA Level I Exam
- Topic 3. Corporate Issuers
- Learning Module 5. Capital Investments and Capital Allocation
- Subject 3. Capital Allocation Principles and Pitfalls
CFA Practice Question
Which of the following statements is false?
B. Cannibalization, when a new project takes sales from an existing product, is one type of externality that occurs.
C. The effect of externalities and cannibalization on cash flow is not incremental and should not be included in the capital allocation decision.
A. Externalities refer to the effect of a project on other parts of the firm.
B. Cannibalization, when a new project takes sales from an existing product, is one type of externality that occurs.
C. The effect of externalities and cannibalization on cash flow is not incremental and should not be included in the capital allocation decision.
Correct Answer: C
Externalities and cannibalization affect the cash flows of a firm and are a direct consequence of accepting a project. Therefore, they affect incremental cash flows and their effect on cash flows should be included in the capital allocation decision.
User Contributed Comments 2
| User | Comment |
|---|---|
| americade | Both types of externalities are incremental and should be used to adjust cash flows. That's the last one is FALSE. |
| ascruggs92 | Negative externalities are non-incremental because they occur regardless of whether the project happens or not. However, they still need to be included in the capital budgeting decision, that's why it is false |