Question

Kenny, Inc., is looking at setting up a new manufacturing plant in South Park. The company bought some land six years ago for $8.5 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. The land would net $11.3 million if it were sold today. The company now wants to build its new manufacturing plant on this land; the plant will cost $22.5 million to build, and the site requires $1,000,000 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?

Answer 1

$34.8 million

Step-by-step explanation:

Below are types of cost that Jenny, Inc. bears:

1) Investment (Six years ago) = $8,5 million (This is referred as sunk cost - which was already incurred and impossible to be recovered.)

2) Current value (Price today) = $11.3 million (This is the opportunity cost if Kenny does not sell the land but build the manufacturing plant.)

3) Plant cost = $22.5 million

4) Grading cost = $1 million

We have, the initial fixed asset investment = Plant cost + Grading cost = 22.5 + 1 = $23.5 million

The cash flow amount to use as the initial investment in fixed assets to evaluate the project would be the sum of the opportunity cost of project anf the initial fixed investment.

=> Cash flow = 11.3 + 23.5 = $34.8 million