Firms A and B are competing for a project. The potential client has provided the following information on a hypothetical project: initial cost is $500,000; building renovation is $600,000; and the building cannot be rented due to the project (currently the building is vacant). Firm B has made the following statement to the board of directors:
We have conducted an extensive analysis of the project and have concluded that your decision should consider the initial cost of $500,000 only. The $600,000 spent on renovation does not affect future cash flow; therefore we can ignore it. The potential rental revenue should be ignored also, as the building is currently empty and therefore is not a cost of this project. The board of directors has asked for your comments on firm B’s statement.