parker & stone inc. is looking at setting up a new manufacturing plant in south

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 its 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?

Explanation / Answer

the following amounts will be the proper cash flows to be used as initial investment in fixed assets.

$6.4 million

NOte:

The purchase price of the land of $6 million is a sunk cost and not relevant for the current project.

The probable cash inflow from the sale of land is relevant since it represents an opportunity foregone by the entity, i.e it would have earned $6.4 million if it were to sell the land without setting up the plant.

sale price of land (opportunity cost)

$6.4 million

cost of plant $14.2 million grading of site $0.89 million Total cash outflows $21.49 million

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