Kenny, Inc., is looking at setting up a new manufacturing plant in South Park. The company bought some land six years ago for $7.3 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. The land would net $10.1 million if it were sold today. The company now wants to build its new manufacturing plant on this land; the plant will cost $23.17 million to build, and the site requires $880,000 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?
The amount of $ 7.3 million paid for the land six years ago is a sunk cost, and hence is not relevant for decision making today.
The fair market values of $ 10.1 million of the land today is an opportunity cost for the investment project, and is therefore relevant.
The proper cash flow amount to use as the initial investment amount is $ 34.15 million.
| Fair market value of land | $ 10,100,000 |
| Cost of construction of plant | 23,170,000 |
| Cost of grading the site | 880,000 |
| Initial Investment in Fixed Assets | $ 34,150,000 |
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