Evaluating Capital Budgeting Decisions
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Carroll Tree Ranch is considering expanding an existing plant on a piece of land it already owns. The land was purchased 15 years ago for $162,500 and its current market appraisal is $410,000. A capital budgeting analysis shows that the plant expansion has a net present value of $65,000. The expansion will cost $865,000, and the discounted cash inflows are $930,000. The expansion cost of $865,000 does not include any provision for the cost of the land. The manager preparing the analysis argues that the historical cost of the land is a sunk cost - a cost that has already been incurred and thus cannot be recovered - and since the firm intends to keep the land whether or not the expansion project is accepted, the current appraisal value is irrelevant.
Should the land be included in the analysis? Explain in great detail why or why not.
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Solution Summary
Carroll Tree Ranch is considering expanding an existing plant on a piece of land it already owns. The land was purchased 15 years ago for $162,500 and its current market appraisal is $410,000. A capital budgeting analysis shows that the plant expansion has a net present value of $65,000. The expansion will cost $865,000, and the discounted cash inflows are $930,000. The expansion cost of $865,000 does not include any provision for the cost of the land. The manager preparing the analysis argues that the historical cost of the land is a sunk cost - a cost that has already been incurred and thus cannot be recovered - and since the firm intends to keep the land whether or not the expansion project is accepted, the current appraisal value is irrelevant.
Should the land be included in the analysis? Explain in great detail why or why not.
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Evaluating Capital Budgeting Decisions
Carroll Tree Ranch is considering expanding an existing plant on a piece of land it already owns. The land was purchased 15 years ago for $162,500 and its current market appraisal is $410,000. A capital budgeting analysis shows that the plant expansion has a net present value of $65,000. The expansion will cost $865,000, and the discounted cash inflows are $930,000. The expansion cost of $865,000 does not include any provision for the cost of the land. The manager preparing the analysis argues that the historical cost of the land is a sunk cost - a cost ...
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