The Corner Market has decided to expand its retail store by building on a vacant lot it currently owns. This lot was purchased four years ago at a cost of $299,000, which the firm paid in cash. To date, the firm has spent another $38,000 on land improvements, all of which was also paid in cash. Today, the lot has a market value of $329,000. What value should be included in the analysis of the expansion project for the cost of the land?

Question

BlackTom AI · Accepted Answer

The scenario asks what value should be included in the expansion analysis for the cost of the land when the Corner Market considers building on a vacant lot it already owns.
Option 1: The sum of the cash paid to date for both the lot and the improvements. This is not appropriate because the $38,000 spent on land improvements and the original $299,000 purchase are sunk costs; they have already occurred and should not affect the incremental decision.
Option 2: The original purchase price only. While intuitive, this ignores the concept of opportunity cost and current value; in capital budgeting, the current opportunities matter more than historical outlays when the asset is already owned, so this is incomplete.
Option 3: The current market value of the land plus the cash paid for the improvements. Here, including both current land value and past improvements double-counts the sunk costs and incorrectly blends values that should be treated separately; improvements are sunk costs and should not be added to the land value for this analysis.
Option 4: The current market value of the land. This aligns with the idea that, for a project involving an asset you already own, the relevant cost is the opportunity cost of using that asset—i.e., what you could sell the land for today. Since the land is already owned, the current market value represents the correct incremental cost of tying up the land in the project.
Option 5: Zero because the land and the improvements were purchased with cash. This is incorrect because it ignores the concept of opportunity cost in capital budgeting; owning the asset means its current value matters for the decision, not that the cost is zero.
In summary, the correct reasoning is that only the current market value of the land matters for the expansion analysis, while past cash outlays on the land and improvements are sunk and should not influence the incremental project decision.

FNBSLW 344-23 Chapter 9 Practice Quiz (not graded)

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