If a Negative Externality Is to Be Internalized to the Decision

question 71

Multiple Choice

If a negative externality is to be internalized to the decision maker, the:

• A) producers' marginal costs should be increased by an amount equal to the marginal cost to those outside the trade that results from production of the good.
• B) producers' marginal costs should be reduced by an amount equal to the marginal cost to those outside the trade that results from production of the good.
• C) consumer of the good should receive a subsidy equal to the marginal cost to those outside the trade that results from production of the good.
• D) consumer of the good should pay a tax equal to the marginal benefit to those outside the trade that results from consuming the good.

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Definitions:

Cost of Capital

The average rate of return a company must pay to its security holders to fund its assets, integrating the cost of debt and equity.

Incremental Cash Flows

The additional cash flow from taking on a new project, considered essential for analysis in capital budgeting.

Sunk Costs

Costs that have already been incurred and cannot be recovered or altered, not affecting future business decisions.

Capital Budgeting

Capital budgeting is the process by which a business evaluates and selects long-term investments based on their potential to generate profitable returns over time.