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?

Question

Business

Ayanna Fuentes

18 February, 01:17

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?

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Answers (1)

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Ross Wolfe · Answer 1

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.