Rowell Company spent $3 million two years ago to build a plant for a new product

Rowell Company spent $3 million two years ago to build a plant for a new product

Question 16

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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?

Answer

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 for any new project.

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.

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.

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.

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.

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