Question

7.[10 points] Fran is considering permanently closing down her beauty salon. A consultant advises her that if she stays open for business, she will have operating revenues of $300,000 and operating costs of $280,000. In addition, Fran has paid $40,000 for fixtures that can be resold for $15,000 after she closes the beauty salon. a. What is the value of Fran's beauty salon if it remains open? b. What is the value of Fran's beauty salon if she closes it? c. Explain whether Fran should close down the beauty salon.

Answer 1

The first thing we need to be clear about is that the $40,000 she has paid for the fixtures is really a sunk cost and hence should not be a part of the analysis. The resale value of $15,000 for these fixtures, however, is something that is dependent on whether the salon is closed or kept open, and needs to be considered.

a. If the salon remains open, the value is Operating revenue - Operating cost = 300,000 - 280,000 = 20,000

b. If the salon is closed, the resale price of the fixtures = 15,000

c. It makes sense to keep the salon open since the value of keeping it open is higher.