Riverton Sails currently produces boat sails and is considering expanding its op

Question

Riverton Sails currently produces boat sails and is considering expanding its operations to include awnings for homes and travel trailers. The company owns land beside its current manufacturing facility that could be used for the expansion. The company bought this land ten years ago at a cost of $89,000 and spent $26,000 on grading and excavation costs at that time. Today, the land is valued at $221,000. The company currently has some unused equipment that it currently owns with a current market value of $45,000. This equipment could be used for producing awnings if $9,000 is spent for equipment modifications. Other equipment costing $315,000 will be required. What is the amount of the initial cash flow for this expansion project?

Explanation / Answer

Solution - Here we need to classify the expenses or Cost as Sunk Costs and Opportunity Cost - Any historical Cost which do not have much importance with respect to the project should be ignored however any opportunity cost which we are giving up for the project should be included in the initial cash flow-

The amount of the initial cash flow for this expansion project

Here we have ignored the Cost of land and other expenses incurred in the Past however we have taken the current market value of Land because that is the Opportunity Cost which we will be giving up if we take this project and that it is why it is included- Similarly the Market Value of old Equipment is included ( as Opportunity Cost)- added additional charges for equipment modifications are included as Capital Expenditure.

Particulars Amt($) A Other equipment 3,15,000 B current market value of unused equipment 45,000 C spenditure on equipment modifications of unused equipment 9000 D Land Value today 2,21,000 E Historical Purchase Cost of Land 89,000 F Historical grading and excavation Cost over Land 26,000 CF Initial Cash Flow ( A+B+C+D) 5,90,000

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