1. Rowell Company spent $3 million two years ago to build a plant for a new prod
ID: 2792647 • Letter: 1
Question
1. Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear—there is no mortgage on it. Which of the following statements is correct? If the statement is not correct, explain why it is not. A) Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows of the capital budgeting analysis for any new project. B) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. C) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. D) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. E) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
1. Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear—there is no mortgage on it. Which of the following statements is correct? If the statement is not correct, explain why it is not. A) Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows of the capital budgeting analysis for any new project. B) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. C) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. D) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. E) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
1. Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear—there is no mortgage on it. Which of the following statements is correct? If the statement is not correct, explain why it is not. A) Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows of the capital budgeting analysis for any new project. B) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. C) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. D) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. E) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
Explanation / Answer
Statements A and B are correct. The building doesn't require any additional cost and hence, it is considered as sunk cost and not included in capital budgeting analysis for any new project.
C is incorrect there is no case of externality here.
D is incorrect because the building is already paid for in the past and doesn't require any cash at the moment.
E is incorrect because the interest cost is considering while calculating the cost of capital.
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