ICMA 13.P2.058

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  • #238655

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    This forum is restricted to members of the associated course(s).

    Kevin Joe Ragadio
    Participant

    Hi Ms. Lynn,

    Hope all is well.

    I got an incorrect answer because I did not include the 20,000 mortgage payoff in the initial cash outflow. The reason I did not include it is because it is an unavoidable cost, and therefore will have to be paid, whether we purchase the new building or not.

    Got a little confused there with the word ‘relevant’. Any tips on how to read these kinds of questions because I think I am interpreting the questions incorrectly.

    Thanks in advance.

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  • #238660

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    Lynn Roden
    HOCK international

    Hello Kevin Joe Ragadio,

    When real estate that has a mortgage on it is sold, any balance remaining on the mortgage must be paid in full out of the proceeds of the sale. The borrower cannot wait to make a payment until the regular payment due date. So when this building is sold, the payoff of the mortgage will be deducted from the proceeds that Charles Company will receive from the sale. Therefore, it is a relevant cash flow.

    Yes, that payment must be made even if the building is not sold. But it would not need to be paid immediately if the building is not sold. Since we have no information beyond that, the only choice is to use the net cash to be received from the sale of the current building (net of the mortgage payoff, that is) in the calculation of the relevant initial cash flows for the new building, because that is what it is.

    A relevant cash flow is an expected future cash flow that differs between alternatives. In identifying relevant cash flows, ask yourself if this cash flow differs between the alternatives that could be selected. If it does, it is relevant to the decision being made.

    Lynn

    #238668

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    Kevin Joe Ragadio
    Participant

    Noted Ms. Lynn, thanks!

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