Question

Your firm is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $4.6 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $5.3 million. The company wants to build its new manufacturing plant on this land; the plant will cost $10.9 million to build, and the site requires $716,578 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?

Topic: Incremental Cash Flows

Answer 1

Solution - To Find the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project -

Relevant Cost - Relevant cost are those cost which affects the decision making. Already incurred cost are irrelevant also known as sunk cost. Relevant cost includes Oppourtunity cost and incremental cost.

Hence,

Relevant Cost = Cost of Pant + Sale Value of land + Cost of Grading

Relevant Cost = $10.90 Million + $5.30 Million + $7,16,578

Relevant Cost = $16.916578 Million.

Hence,

The proper cash flow amount to use as the initial investment in fixed assets when evaluating this project is $16.916578 Million.

If you have any query related to question then feel free to ask me in a comment. Thanks.