Question

A house renovator has spent $170,000 to purchase a house and fix it up for resale, which she expects to sell for $280,000 once complete. She has worked one month and spent $40,000 in renovation costs, and just purchased $30,000 of materials to finish the renovation. Today, she discovers mold, electrical, and other issues that will cost $15,000 combined. She expects the house to be done 2 months from today and her opportunity cost of time is $8000 per month. If she decides not to finish the renovation but fix the mold, electrical, and other issues, she can sell the house for $240,000.

a) What is her marginal opportunity cost of finishing the project assuming the $30,000 materials cost is sunk? What is the marginal benefit of finishing? Should she finish?

b) What are your answers to part (a) if the $30,000 in materials is refundable or can be used on another house?

c) What amount of the materials would need to be sunk to induce her to finish the project?

Answer 1