Question

Home Builder Supply, a retailer in the home improvement industry, currently operates seven retail outlets in Georgia and South Carolina. Management is contemplating building an eighth retail store across town from its most successful retail outlet. The company already owns the land for this store, which currently has an abandoned warehouse located on it. Last month, the marketing department spent $10,000 on market research to determine whether to build and open the new store. Which of the following should be included as part of the incremental free cash flows for evaluating the proposed new retail store?

A.	The interest paid on the bridge loan used to finance construction costs construction costs of the new retail store.

B.	The expected loss of sales at its existing retail outlet, if customers who previously drove across town to shop at the existing outlet become customers of the new store instead.

C.	The $10,000 in market research spent to evaluate customer demand.

D.	The dividends be paid out to shareholders from the new store’s profits.

E.	The cost of managers’ time and effort spent so far evaluating the new store.

Answer 1

A - Not To be included as financing cost is already included in the discount rate used to discount the cashflows.

B - To be included, This is called the Cannibalization which is when the new project takes sales away from the existing product as happenign in this case.

C - Not to be included, this is called Sunk cost and would be spend irrespective of whether the project is selected or not.

D - Not to be included.As this is not a mandatory event and could be avoided.

E - Not to be included similar to C