Diamond Inc. has estimated that a new building will cost $2,500,000 to construct. Land was purchased a year ago for $500,000 and could be sold today for $550,000. An environmental impact study required by the state was performed at a cost of $48,000. For capital budgeting purposes, what is the relevant cost of the new building?
A) $2,500,000
B) $3,048,000
C) $3,050,000
D) $3,098,000

Question

Quizplus · Accepted Answer

The relevant cost of the new building includes the cost of constructing the building ($2,500,000) and any additional costs that are directly related to the project and cannot be avoided. The cost of the land, which was purchased a year ago for $500,000 and could be sold today for $550,000, is not a relevant cost because it is a sunk cost (already incurred and cannot be recovered). Similarly, the cost of the environmental impact study ($48,000) is not a relevant cost because it is an incremental cost (resulting from the decision to undertake the project) but it is not directly related to the construction of the building. Therefore, the relevant cost of the new building is $2,500,000 + $0 = $2,500,000.