Parker & Stone, Inc., is looking at setting up a new manufacturing plant in Sout
ID: 2631271 • Letter: P
Question
Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5.6 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $5.9 million. The company wants to build its new manufacturing plant on this land; the plant will cost $13.1 million to build, and the site requires $830,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project?
Explanation / Answer
The $5.6 million acquisition cost of the land six years ago is a sunk cost. The
$5.9million current after-tax value of the land is an opportunity cost if the land is used
rather than sold off.
The $13.1 million cash outlay and $830,000 grading expenses
are the initial fixed asset investments needed to get the project going.
Therefore, the
proper year zero cash flow to use in evaluating this project is
$5,900,000 + 13,100,000 + 830,000 = $19,830,000