Consider this example: ACME Roadkill, Inc. is looking at setting up a new manufa
ID: 2624871 • Letter: C
Question
Consider this example: ACME Roadkill, Inc. is looking at setting up a new manufacturing plant in Alien Landing, NV. The company bought some land four years ago for $7 million in anticipation of using it as a training facility, but the company has since decided to lease facilities elsewhere. The land was appraised last week for $5.2 million. The company now wants to build its new manufacturing plant on this land; the plant will cost $12 million to build, and the site requires $1 million worth of draining used oil before it is suitable for construction. What is the proper cash flow amount that they should use as the initial investment in fixed assets when evaluating this project?
a. $0, the cost of the land is a sunk cost.
b. $5.2 million, the appraised value of the land.
c. $7 million, the original cost of the land.
d. $17.2 million, the appraised value of the land plus construction costs.
e. $18.2 million, the appraised value of the land plus improvements and draining.
f. $20 million, the original cost of the land, plus improvements, plus the draining cost.
Explanation / Answer
Hi,
Please find the detailed answer as follows:
Acqusition Cost of Land (7 Years Ago) is a sunk cost and hence not relevant.
Initial Investment in Fixed Assets = 5.2 (Appraised Value) + 12 (Cost of Building Plant) + 1 (Cost of Draining Used Oil) = 18.2 million
Option E ( $18.2 million, the appraised value of the land plus improvements and draining) is the correct answer.
Thanks.