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 $4.5 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 $4.7 million. The company wants to build its new manufacturing plant on this land; the plant will cost $10.6 million to build, and the site requires $736,969 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

Here,

1.Cost at which land was bought six years ago i.e $ 4.5 million is a sunk cost.

2. Cost of land today is the opportunity cost which will be lost if the manufacturing plant is built on this land = $ 4.7 million

3. Cost of the plant to build = $ 10.6 million

4. cost of grading the site = $ 736,969

Therefore,

Initial Investment will be =Opportunity cost + Cost of the plant to build + cost of grading the site

= $ 4,700,000 + $ 10,600,000 + $ 736,969

= $ 16,036,969

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