1. Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?
The new project is expected to reduce sales of one of the company’s existing products by 5%.
The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.
The company has spent and expensed $1 million on R&D associated with the new project.
Since the firm’s director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project’s initial cost.
2. Which of the following statements is correct?
Cannibalization is a type of externality that is not against the law, and any harm it causes is done to the firm itself.
If cannibalization is determined to exist, then this means that the calculated NPV considering cannibalization will be higher than the NPV that does not recognize these effects.
If a project can create employment in a slump area, firm should include such an externality in the NPV calculations.
If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. Otherwise, the calculated NPV will be biased downward.