Home Builder Supply, a retailer in the home improvement industry, currently oper

Question

Home Builder Supply, a retailer in the home improvement industry, currently operates seven retail outlets in Georgia and South Carolina. Management is contemplating building an eighth retail store across town from its most successful retail outlet. The company already owns the land for this store, which currently has an abandoned warehouse located on it. Last month, the marketing department spent $10,000 on market research to determine the extent of customer demand for the new store. Now Home Builder Supply must decide whether to build and open the new store. Which cost(s) in the following list should be included in capital budgeting process for the proposed new retail store? (1 point) (1) The original purchase price of the land where the store will be located. (2) The cost of demolishing the abandoned warehouse and clearing the lot. (3) The loss of sales in the existing retail outlet, if customers who previously drove across town to shop at the existing outlet become customers of the new store instead. (4) The $10,000 in market research spent to evaluate customer demand. (5) Construction costs for the new store. (6) The value of the land if sold.

Explanation / Answer

Answer:

Following explanations can be considered for the costs given:

(1) The original purchase price of the land where the store will be located:

It should be considered while evaluating the proposal tio determine the fall / rise in the price of the land till the project continues.

(2) The cost of demolishing the abandoned warehouse and clearing the lot.

This is relevant cost as it is being incurred exclusively for the project. Hence should be considered for evaluation of project.

(3) The loss of sales in the existing retail outlet, if customers who previously drove across town to shop at the existing outlet become customers of the new store instead.

This loss should also be considered as it is incurred due to acceptance of proposal or we can say this is opportunity cost and opportunity cost is relevant for decision making process.

(4) The $10,000 in market research spent to evaluate customer demand.

This cost is Sunk cost (Past cost) hence irrelevant for the decision making, hence it should be ignored.

(5) Construction costs for the new store

This is incremental cost and hence should be considered for decision making.

(6) The value of the land if sold.

Yes this shall be considered to calculate the opportunity cost (Fall / rise in the value of assets used)

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