Question

Alpaca Inc. purchased a corner lot in 2010 at a cost of $500,000. The lot was recently appraised at $800,000. At the time of the purchase, the company spent $25,000 to grade the lot and has been leasing this place as a parking lot for $10,000 a year. The renewal for the lease contract was not expected to expire until 2030. The company now wants to build a new retail store on the site. The building cost is estimated at $75,000.

* Choose all values to be considered and included in calculating the free cash flows for capital budgeting.

1. Purchase price of the corner lot @ $500,000
2. Appraisal of $800,000
3. Grading @ $25,000
4. Parking lot lease @ $10,000 per year
5. Cost to build a new retail store @ $75,000

Group of answer choices

* Choose all values to be considered and included in calculating the free cash flows for capital budgeting.

1. Purchase price of the corner lot @ $500,000
2. Appraisal of $800,000
3. Grading @ $25,000
4. Parking lot lease @ $10,000 per year
5. Cost to build a new retail store @ $75,000

Group of answer choices

I and IV only

II and V only

II, III, and IV only

II and IV only

II, IV and V only

Answer 1

I. Purchase price of the corner lot @ $500,000 : This is a sunk cost which is already incurred and does not influence or impact the future cash-flow. Hence this cost should not be considered and included in calculating the free cash flows for capital budgeting.

II. Appraisal of $800,000 : This is a relevant cost as this will become a opportunity cost if the new retail store is built. Hence this cost should be considered and included in calculating the free cash flows for capital budgeting.

III. Grading @ $25,000 : This is a sunk cost which is already incurred and does not influence or impact the future cash-flow. Hence this cost should not be considered and included in calculating the free cash flows for capital budgeting.

IV. Parking lot lease @ $10,000 per year : This is a relevant cost as this will become a opportunity cost if the new retail store is built as the income from leasing the parking lot would be foregone by building a new store. Hence this cost should be considered and included in calculating the free cash flows for capital budgeting.

v. Cost to build a new retail store @ $75,000 : This is a relevant cost as this is the investment cost of building a new retail store. Hence this cost should be considered and included in calculating the free cash flows for capital budgeting.

Thus, answer is II, IV and V only