Question

Bruce Moneybags owns several restaurants and hotels near a local interstate. One restaurant, Beef and More, originally cost $1.8 million, is currently fully paid for, but needs modernized. Bruce is trying to decide whether to accept an offer and sell Beef and More, as is, for the offer price of $1.1 million or renovate the restaurant himself. The projected renovation cost is $1.3 million. The restaurant would need to be shut down completely during the renovation which would cause an aftertax net loss of $90,000 in today's dollars. The estimated present value of the cash inflows from the renovated restaurant is $3.2 million. When analyzing the renovation project, what cost, if any, should be included for the current restaurant?

Answer 1

Answer:

The cost should be included when analyzing the renovation project is $1.390.000

Explanation:

When analyzing the renovation project we should include the renovation cost plus the loss because the restaurant will be close.  

That will be:  

$1.300.000 + $90,000=1.390.000

• Originally cost $1.8 million, is a stranded cost is not part of the renovation project.

• $1.1 million is the opportunity cost, so we shouldn't include it  as a renovation cost.  The managers will compare the IRR (Internal rate return) with this amount.  If IRR is bigger than the opportunity cost, is convenient to make the renovation.