Parker & Stone, Inc., is looking at setting up a new manufacturing plant in Sout
ID: 2669279 • 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 $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 $6.4 million. The company wants to build it’s new manufacturing plant on this land; the plant will cost $14.2 million to build, and the site requires $890,000 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? Why?I need help double checking my homework please help if you can.
Explanation / Answer
This relates to decision making where ONLY relevant costs are considered. 1. Cost of land is sunk cost and not relevant 2. If the company goes ahead with building the plant it will lose rental revenue, which is an opportunity cost. 3. If the company goes ahead with building the plant it will lose the proceeds from sale of land amounting to $6.4 million, which again is an opportunity cost 4. If the company goes ahead with building the plant it will incur $14,200,000 + 890,000 = $15,090,000, a relevant cost.