The managers of H.R Construction are considering remodelling plans for an old building the firm currently owns.The building was purchased eight years ago for $689 000.Over the past eight years,the firm rented out the building and used the rent to pay off the mortgage.The building is now owned free and clear and has a current market value of $898 000.The firm is considering remodelling the building into a conference centre and sandwich bar at an estimated cost of $1.7 million.The estimated present value of the future income from this centre is $2.9 million.Which one of the following defines the opportunity cost of the remodelling project?

Question

Quizplus · Accepted Answer

The opportunity cost of the remodelling project is the cost of the next best alternative that would be foregone, which in this case is the current market value of the building. The firm could choose to sell the building for $898,000 and invest the proceeds elsewhere, which would be the opportunity cost of choosing to remodel instead. The initial cost of the building, cost of the remodelling, and the initial cost of the building plus the remodelling costs are irrelevant to the opportunity cost of the remodelling project. The current market value of the building plus the remodelling costs overestimates the opportunity cost because it includes the cost of the remodelling project which will incur regardless of whether the building is sold or remodeled.

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