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Larry's PX purchased a lot in Muscogee five years ago. They paid $640,000 for the property....

Larry's PX purchased a lot in Muscogee five years ago. They paid $640,000 for the property. Today, the lot has a market value of $890,000. When Larry's PX purchased the lot, they spent $41,000 to level it and an additional $3,300 to install storm drains. The company is now considering using the lot as the site for a new building. The building itself is expected to cost $1,130,000. What amount should be used as the overall initial cash flow for this building project?

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Answer #1

The historical acquisition cost is a sunk cost and is not relevant. For the same reason, the cost of leveling and installing storm drains are irrelevant because they are historical and therefore sunk costs.

However, the market value of the lot today is a relevant cash flow, and should therefore be considered.

overall initial cash flow = -(market value of lot today + building cost)

overall initial cash flow = -($890,000 + $1,130,000)

overall initial cash flow = -$2,020,000

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