Question

Alpaca Inc. purchased a corner lot in 2010 at a cost of $500,000. The lot was recently appraised at $800,000. At the time of the purchase, the company spent $25,000 to grade the lot and has been leasing this place as a parking lot for $10,000 a year. The renewal for the lease contract was not expected to expire until 2030. The company now wants to build a new retail store on the site. The building cost is estimated at $75,000.

* Choose all values to be considered and included in calculating the free cash flows for capital budgeting.

1. Purchase price of the corner lot @ $500,000
2. Appraisal of $800,000
3. Grading @ $25,000
4. Parking lot lease @ $10,000 per year
5. Cost to build a new retail store @ $75,000

Answer 1

Purchase price of the corner lot ie $500000 is a sunk cost as it a cost already undertaken which does not impact our current decision.

The appraisal value of $80000 the lot shall be considered as that is the amount someone has paid for buying the lot today.

Grading of $25000 does not needs to be considered as the same is sunk cost.

Parking lot lease $10000 needs to be considered as outflow as we will loosing the same if retails store is made over the same.

Cost to be build a new retails store $75000 needs to considered while calculating the capital budget as the same is direct costs linked with the retail stores.