Question

In 1985, Alice paid $20,000 for an option to purchase ten acres of land. By paying the $20,000, she bought the right to buy the land for $100,000 in 1992. When she acquired the option in 1985, the land was worth $120,000. In 1992, it is worth $110,000. Should Alice exercise the option and pay $100,000 for the land? A) Yes. B) No. C) It depends on what the rate of inflation was between 1985 and 1992. D) It depends on what the rate of interest was.

Answer 1

Answer:

The answer is: Yes

Explanation:

The money Alice paid in 1985 ($20,000) is considered a sunk cost.

A sunk cost is money already spent that cannot be recovered.

So if Alice decides to buy the land or not, she will not recover a cent from the $20,000 she paid before.

Since the current price of the land is $110,000 and Alice can purchase it for $100,000, then she should buy it. She is going to earn a $10,000 profit.