Beckingham Sports is an American sporting goods company. Based on a $400,000 market study and a $600,000 feasibility opinion concluded last year, Beckingham believes it can increase its annual operating cash flow by $3,000,000 by opening new overseas locations. In preparation for the expansion, the firm spent $2,000,000 to purchase land for a new factory. However, the company just received an offer of $3,000,000 for the land purchased for the new factory. Beckingham is now ready to make a final decision on the international expansion. Of the outlays mentioned, which is relevant for capital budgeting purposes?

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BlackTom AI · Accepted Answer

First, let's restate the scenario and the options to anchor the discussion:
- Scenario: Beckingham Sports is evaluating an international expansion. They have various cash outlays: $600,000 for a market study, $400,000 for a feasibility opinion, and $2,000,000 spent to purchase land for a new factory. They received an offer of $3,000,000 for the land. The question asks which outlays are relevant for capital budgeting purposes.
- Answer options:
  1) $3,000,000 for the offer price of the land
  2) $600,000 for the consulting
  3) $400,000 for the market study
  4) $2,000,000 to purchase the new land

Now, evaluate each option in terms of relevance to capital budgeting decisions.
Option 1: $3,000,000 for the offer price of the land. This represents the opportunity cost of using the land for expansion versus selling it now. In capital budgeting, opportunity costs (the foregone cash inflows from the best alternative use) are relevant because they affect the incremental cash flows of the project. If the company proceeds with the expansion, the alternative of selling the land for $3,000,000 is foregone, making this amount a relevant consideration. This is the classic example of an opportunity cost being included in project analysis.
Option 2: $600,000 for the consulting. This is a prior the decision cost (a sunk or pre-decision expenditure) that has already been incurred and does not affect future cash flows under the chosen project. Sunk costs are not included in capital budgeting analyses because they do not change with the decision at hand.
Option 3: $400,000 for the market study. Like the consulting, the market study is a sunk cost that was incurred before the decision point. While it informs the decision, it is not a cash flow that will occur or be avoided as a direct result of accepting or rejecting the project, so it is not included in the incremental cash flows.
Option 4: $2,000,000 to purchase the new land. This is the initial outlay that would be required if the project proceeds. However, in the context of this question, the land has already been purchased for $2,000,000, so this amount is a sunk cost for the contemplated decision and does not constitute an incremental future cash flow. Sunk costs are excluded from capital budgeting because they do not differ between the alternatives.

To summarize the distinctions, only the foregone sale value of the land—the opportunity cost of not selling the land if the expansion proceeds—represents an incremental cash flow relevant to the decision. The other outlays are sunk costs and/or do not represent future incremental cash flows and thus are not considered in capital budgeting analysis.

Therefore, the option describing the $3,000,000 offer price of the land (the opportunity cost) is the relevant item for capital budgeting purposes, while the others are not.

MSB-250-300-002 Topic 12 Quiz

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