Venus Corporation is a construction company operating in Massachusetts. The company has begun the development of a new housing sub-division. The lots and initial construction materials have been purchased, and framing has begun. A total of $4 million has been invested.

Suddenly, a crisis in the banking industry causes a recession, and subsequently, the bottom falls out of the housing market. The sub-division land is now worth much less than the construction company paid for it. If the company abandons the project, it will take a $4 million loss. Some company executives want to finish the houses and sell them to recover at least a portion of the costs already spent. But it will require an additional $6 million to complete the project. One of the executives, M. Morrison said “we have already spent 4 million; we might as well finish the project”. Another executive, S. Noreen doesn’t agree with Morrison, according to her “It doesn’t matter that we have already spent $4 million, this cost is not relevant for decision making”. Since there are huge uncertainties surrounding the housing market the company can’t predict the selling price of the finished housing project exactly but the company is sure that the selling price will not be more than $6 million.  

Required: (2 + 2 + 2 = 6)

a)            According to S. Noreen the $4 million cost is not relevant for decision making, do you agree? If ‘yes’ why, if ‘no’ why not?

b)            Explain differential cost. What are two alternatives in this case & what is the differential cost?

c)            Do you think the company should finish the project? Give your own arguments?

Answer rating: 100% (QA)

a The statement by noreen is correct The 4 mollion which is already spended is irrelevant for decisi... View the full answer