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LW Co has a half empty factory on which it pays $5,000 pa rent. If it takes on a new project, it will have to
move to a new bigger factory costing $17,000 pa and it could rent the old factory out for $3,000 pa until the
end of the current lease.
What is the rental cost to be included in the project appraisal?Hi sir can you please explain this question? I thought the answer was 19000 but it’s 14000. I understand that the new cost of the old factory will be 2000 and 17000 for the new factory will make a total of 19000 but why do we need to remove the 5000 of the old factory again? We already calculated the incremental cashflow.
The $5,000 is not relevant because they will be paying the rent whether or not they move to a bigger factory. (We know they will be still paying it because if they weren’t they would not be able to rent it out to someone else.)
If they do move to the bigger factory they will be paying $17,000 per year. They will rent out the old factory and so will be receiving $3,000 per year.
Therefore the net cost is 17,000 – 3,000 = $14,000 per year.
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