Question

Burning Man, Inc., wants to build a new park area for music festivals. 10 years ago they bought some land in a remote area for $7.7 million thinking this could be used to store art cars when not being used. They never used it for this purpose and thus the land has been sitting unused. They have had to pay taxes and other costs of $200,000 per year for the last 10 years that they have owned the land. They could sell the land today and would generate a net amount of $10.5 million if they sold it. Burning Man has now concluded that this remote location would be a perfect site to develop for music festivals. It will cost them $21.7 million to do all of the construction plus they will need to spend $920,000 on grading improvements to the land to get it ready for development.  

Calculate the appropriate cash flow amount that should be used by Burning Man, Inc. for this beginning investment in fixed assets for purposes of evaluating this new project.

Answer 1

The $7.7 million cost of the land 10 years ago is a sunk cost and irrelevant. The taxes and costs of $200,000 per year for the last 10 years are also a sunk cost and irrelevant.

The $10.5 million net sale price of the land today is an opportunity cost and is relevant. The cost of construction and improvements are incremental cash flows, and are relevant.

Total cash flow amount of fixed assets =  net sale price of the land today + cost of construction and improvements

Total cash flow amount of fixed assets =  $10.5 million + $21.7 million + $920,000

Total cash flow amount of fixed assets =  $33.12 million