Question

You have just completed a $24000.0 feasibility study for a new coffee shop in some retail space you own. You bought the space two years ago for $96,000, and if you sold it today, you would receive $112,000, after taxes. Taking the coffee shop would require a capital expenditure of $33,000 plus an initial investment of $5,400 in inventory. What is the correct initial cash flow for your analysis of the coffee shop opportunity?

Answer 1

In this sum, there is concept of sunk cost and opportunity cost.

The feasibility study of $24,000 will not be considered in the project as this cost is irrecoverable and acceptance or rejection of project will not alter the cost. So this cost is already incurred. This is an example of sunk cost.

As the owner already had the land which can be sold for $112,000 so this is an opportunity cost. If the owner is not doing the project then he can earn $112,000. As he is giving up this opportunity, so this cost should be added with the initial outflow of the project.

Rest capital expenditure and initial investment in inventory needs to be added to initial outflow.

Correct Initial outflow = Opportunity Cost + Capital Expenditure + Initial Investment in inventory

= 112,000 + 33,000 + 5,400

= 150,400

So the initial outflow is $150,400

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