Question

Opportunity cost.  Revolution Records will build a new recording studio on a vacant lot next to the operations center. The land was purchased five years ago for ​$400 comma 000400,000. ​ Today, the value of the land has appreciated to ​$800 comma 000800,000. Revolution Records did not consider the value of the land in its NPV calculations for the studio project​ (it had already spent the money to acquire the land long before this project was​ considered). The NPV of the recording studio is ​$570 comma 000570,000. Should Revolution Records have considered the land as part of the cash flow of the recording​ studio? If​ yes, what value should be​ used, ​$400 comma 000400,000 or ​$800 comma 000800,000​? How will the value affect the​ project?

Answer 1

A)Since the vacant land was purchased in past ,The purchase cost of land is irrelevant .However if new recording studio is built on land ,the opportunity to sell land at current market value is lost ,Thus current market value of land is a relevant cost to be considered in decision making

B)The value of land to be considered : 800,000

c)The value of project (NPV ) will fall by 800,000 (as initial investment will increase by 800000) Thus overall NPV will be 570000- 800000 = - 230000