1. Concepts used in cash flow estimation and risk analysis

You can come across different situations in your life where the concepts from capital budgeting will help you in evaluating the situation and making calculated decisions. Consider the following situation:

The following table contains five definitions or concepts. Identify the term that best corresponds to the concept or definition given.

Concept or Definition

Term

An example of externality that can have a negative effect on a firm

The cash flow at the end of the life of the project

The risk of a project without factoring in the impact of diversification

A risk analysis technique that measures changes in the internal rate of return (IRR) and net present value (NPV) as individual variables are changed

The owner of Caf Bakka is considering investing in new point-of-sale technology. He spent $10,000 on his current point-of-sale system five years ago. The new point-of-sale technology will cost $25,000, but it will dramatically improve the speed at which his counter staff will be able to take orders; it will also reduce the owners administrative work. How should the owner account for the cost of the current point-of-sale technology when performing his capital budgeting analysis to determine whether or not to purchase the new point-of-sale technology?

He should include half of the cost of the current point-of-sale system when evaluating the cost of the new point-of-sale system.

He should include the cost of the current point-of-sale system as part of the cost of the new point-of-sale system.

He should ignore the cost of the current point-of-sale system when evaluating the cost of the new point-of-sale system.

A large soft-drink company currently produces regular cola and diet cola. It is considering introducing a new soft drink that tastes like regular cola but has zero calories like the diet cola. The new zero-calorie drink that tastes like regular cola is most likely to produce externality.