REVIEW FOR FINAL

Explain in detail why these answers are correct and how they are determined

a. No, this is a sunk cost and will not be included directly. (But see part (f) below.)

b. Yes, this is a cost of opening the new store.

c. Yes, this loss of sales at the existing store should be deducted from the sales at the new store to determine the incremental increase in sales that opening the new store will generate for HBS.

d. No, this is a sunk cost.

e. This is a capital expenditure associated with opening the new store. These costs will therefore increase HBSs depreciation expenses.

f. Yes, this is an opportunity cost of opening the new store. (By opening the new store, HBS forgoes the after-tax proceeds it could have earned by selling the property. This loss is equal to the sale price less the taxes owed on the capital gain from the sale, which is the difference between the sale price and the book value of the property. The book value equals the initial cost of the property less accumulated depreciation.)

g. While these financing costs will affect HBSs actual earnings, for capital budgeting purposes we calculate the incremental earnings without including financing costs to determine the projects unlevered net income.

Capital Budgeting Home Builder Supply, a retailer in the home improvement industry, currently operates seven retail outlets in Georgia and South Carolina. Management is contemplating building an eighth retail store across town from its most successful retail outlet. The company already owns the land for this store, which currently has an abandoned warehouse located on it. Last month, the marketing department spent $10,000 on market research to determine the extent of customer demand for the new store. Now Home Builder Supply must decide whether to build and open the new store. Which of the following should be included as part of the incremental earnings for the proposed new retail store? a. The original purchase price of the land where the store will be located. b. The cost of demolishing the abandoned warehouse and clearing the lot. c. The loss of sales in the existing retail outlet, if customers who previously drove across town to shop at the existing outlet become customers of the new store instead d. The $10,000 in market research spent to evaluate customer demand. e. Construction costs for the new store. f. The value of the land if sold. g. Interest expense on the debt borrowed to pay the construction costs. 31