Kenny Inc. Is Looking To Set Up A New Manufacturing Plant

Kenny Inc Is Looking At Setting Up A New Manufacturing Plant In Sou

Kenny Inc. is evaluating the initial investment required for establishing a new manufacturing plant in South Park. Previously, the company purchased land six years ago for 7.2 million dollars with the intention of using it as a warehouse and distribution site. However, the strategic decision has shifted, and the company now plans to build its manufacturing facility on this land. The land has a current market value of 10.0 million dollars if sold today. The construction of the plant is estimated to cost 21.2 million dollars, and the site requires an additional 870,000 dollars for grading to prepare it for construction.

The goal is to determine the proper cash flow amount to be used as the initial investment in fixed assets when evaluating this project. This calculation must consider relevant costs and benefits, including potential proceeds from land sale and any additional initial expenses.

Paper For Above instruction

When evaluating capital investment projects, determining the correct initial cash flow is essential as it significantly influences the project's feasibility assessment and financial decision-making. The initial investment typically encompasses all expenditures necessary to acquire and prepare the asset for operation. In the context of Kenny Inc.'s proposed manufacturing plant, this amount should reflect the net cash outflow related to acquiring or utilizing the land and setting up the infrastructure needed for operational readiness.

Firstly, the land's current market value provides an important insight. Since Kenny Inc. has the option to sell the land today for 10.0 million dollars, this value represents the opportunity cost of using the land for the project. Therefore, the net cash flow associated with land should account for its sale value, as the decision to develop the land negates its sale. The land's book value of 7.2 million dollars is irrelevant here because the decision is based on the current market value, which reflects the opportunity cost.

Secondly, the costs associated with preparing the land for construction should be incorporated into the initial outlay. The grading cost of 870,000 dollars is a direct expenditure incurred to ready the site for building the manufacturing facility. Since this expense is necessary for project completion, it is included in the initial investment.

Thirdly, the construction cost of 21.2 million dollars must also be considered. This amount represents the cash expenditure necessary for building the manufacturing plant. Inclusion of this cost in the initial investment provides a comprehensive view of the capital outlay required to commence operations.

Therefore, the total initial cash flow should be calculated by subtracting the net proceeds from potentially selling the land from the total investment costs associated with construction and land preparation. In this case, since the company plans to build the plant on the land and not sell it, the land's opportunity cost is factored in as if the land is not sold, meaning the project bears the opportunity cost of 10.0 million dollars. However, the cash flow calculation for project evaluation typically considers the actual cash spent rather than opportunity costs unless explicitly evaluated as an economic comparison.

Given these points, the correct initial cash flow amount includes the cost of grading and the construction cost. The net cash flow initially invested, considering the land's opportunity cost—aligned with capital budgeting principles—would be the actual cash outlay: the construction cost plus grading expenses, net of any cash received from land sale if the land were sold instead of used. Since the land will be used for the project, the relevant initial cash flow is the sum of the construction cost and grading, totaling 21.2 million + 870,000 dollars, which equals 22.07 million dollars.

In conclusion, the proper initial investment in fixed assets for project evaluation purposes involves the total expenditure necessary to acquire and ready the asset for use, which, in this context, is the sum of the construction and grading costs. The opportunity cost of land is typically considered in economic evaluations but not directly included as a cash outflow in the initial investment unless the land is sold and proceeds are used for the project. Since the land is not being sold but used, the initial investment is 21,200,000 + 870,000 = 22,070,000 dollars.

Answer: 22070000

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