Effects of a Project on Cash Flows in Other Parts of the Firm

Explanation

Externalities are defined as effects of a project on cash flows in other parts of the firm

The correct answer is E. Externality.

Let's break down the options and their meanings to understand why "Externality" is the correct term for the effects of a project on cash flows in other parts of the firm:

A. Cannibalization: Cannibalization refers to the situation where a new product or project within a firm reduces the sales or profitability of an existing product or project. It is not specifically related to the effects on cash flows in other parts of the firm.

B. Sunk Cost: Sunk costs are costs that have already been incurred and cannot be recovered. They are not directly related to the effects on cash flows in other parts of the firm caused by a project.

C. Incremental Cash Flow: Incremental cash flow refers to the additional cash flow generated or expended as a result of a particular project or investment. While this term is related to the concept of cash flows, it does not specifically capture the effects on cash flows in other parts of the firm.

D. Opportunity Cost: Opportunity cost is the cost of forgoing the next best alternative when making a decision. While it is a relevant concept in financial analysis, it does not specifically address the effects on cash flows in other parts of the firm caused by a project.

E. Externality: An externality occurs when the actions or decisions of one economic agent affect the well-being of another agent, without any compensation being paid. In the context of the question, the effects of a project on cash flows in other parts of the firm can be seen as an externality. These effects are external to the project itself but impact other areas or divisions within the firm. Therefore, "Externality" is the most suitable term to describe the given scenario.

In summary, the effects of a project on cash flows in other parts of the firm are referred to as an "externality."