Question

Last year, you purchased land to build a retail store. You paid $20 million for the land. Another business has now offered $8 million for the land and that is the highest price your business should now be able to get for the land. Which of the following costs is relevant for your decision as to whether or not you should build a new retail store?

a. $8 million
b. $12 million
c. $20 million
d. $28 million

Answer 1

The relevant cost for deciding whether to build a retail store or sell the land is the current offer of $8 million, as the original purchase price is a sunk cost and not relevant for future decisions. The decision should consider potential retail store profits versus the sale offer.

Step-by-step explanation:

In the scenario you provided, the relevant cost for the decision as to whether or not you should build a new retail store is $8 million. This is the highest price that your business would be able to get for the land currently. The original purchase price of $20 million is a sunk cost, meaning it has already occurred and cannot be changed; therefore, it is irrelevant for future decision-making. When assessing whether to build the retail store or sell the land, your business should consider the potential profit from the retail operation versus the current sale offer of $8 million.

It's also important to consider the example given where a center earns revenues of $20,000 and has variable costs of $15,000. In this case, the center should continue in business as it's covering its variable costs and contributing towards fixed costs and possibly making a profit.