Question

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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

$ 15 comma 000$15,000

on market research to determine the extent of customer demand for the new store. Now Home Builder Supply must decide whether to build and open the new store.

Which of the following should be included as part of the incremental earnings for the proposed new retail​ store?

a. The original purchase price of the land where the store will be located.

b. The cost of demolishing the abandoned warehouse and clearing the lot.

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

d. The

$ 15 comma 000$15,000

in market research spent to evaluate customer demand.

e. Construction costs for the new store.

f. The value of the land if sold.

g. Interest expense on the debt borrowed to pay the construction costs.

Answer 1

a. The original purchase price of the land where the store will be located.

This cost is already incurred. It is a sunk cost. This will not impact or influence the future cash flows from opening the new store. Hence this should not be included as part of the incremental earnings for the proposed new retail​ store.

b. The cost of demolishing the abandoned warehouse and clearing the lot.

This is a relevant cost as if the new store is not opened, there may not be a need to demolish the abandoned warehouse and clear it. Hence this should be included as part of the incremental earnings for the proposed new retail​ store by considering this as an additional cost.

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

This is a relevant cost - opportunity cost of opening the new store. Opening the new store reduces the sales of the existing store which otherwise would not have affected if the new store is not opened. Hence this should be included as part of the incremental earnings for the proposed new retail​ store by considering this as an additional cost.

d. The $15,000 in market research spent to evaluate customer demand.

This cost is already incurred. It is a sunk cost. This will not impact or influence the future cash flows from opening the new store. Hence this should not be included as part of the incremental earnings for the proposed new retail​ store.

e. Construction costs for the new store.

This is a relevant cost directly associated with opening the new store. This expense could have been avoided if the new store is not opened. Hence this should be included as part of the incremental earnings for the proposed new retail​ store by considering this as an cost.

f. The value of the land if sold.

This is a relevant cash inflow - opportunity cost of opening the new store. Had the new store not opened, the land could have been sold at a value. Hence this should be included as part of the incremental earnings for the proposed new retail​ store by considering this as an cost.

g. Interest expense on the debt borrowed to pay the construction costs.

This is a relevant cost directly associated with opening the new store. This expense could have been avoided if the new store is not opened. Hence this should be included as part of the incremental earnings for the proposed new retail​ store by considering this as an cost.