Sam owns outright no mortgage payments two plots of land of

Sam owns outright (no mortgage payments) two plots of land of equal size in Southern California. One plot is in Victorville (the High Desert) and the other is in the coastal community of Newport Beach. Sam was thinking about going into the self-storage business by building a self-storage facility on one of his two pieces of property. Sam did some calculations and he noticed that the monetary cost (direct payments of money) to build and operate a self-storage facility in either location would be identical over the next ten years with a dollar amount of $2 million. Sam did more calculations and he concluded that either location would bring in the identical revenue over the same ten-year period with a dollar amount of $5 million.

Thus, Sam concluded that it did not matter which location he built his self-storage facility because the bottom line (profit) of $3 million over ten years is identical for each location. After ten years, Sam plans to sell both plots of land and then retire to France. In the meantime Sam will be living in downtown LA conducting his business from there (thus Sam will not need to travel to either location – hence where Sam lives now or later has nothing to do with this question).

Given that Sam’s calculations were correct on the costs of building and operating the self-storage facilities and on the revenue, please explain why Sam’s conclusion is incorrect.

Remember, Sam’s calculations are 100% correct. It is only his conclusion that is incorrect. Do not question his numbers in your answer. His numbers are, again, 100% ironclad correct. Your answer needs to be directed only at his conclusion.

Solution

Hi,

The correct answer is as follows:

Sam’s conclusion is wrong because he has not considered the resell cost of the plots and the storage facility. Sam plans to sell off both his plots and storage facility after 10 years. However, he is assuming that the resell value from these would be the same. Or maybe he has not even considered the resell value. So, given that the profit is same for the two locations, the only variable factor here is the re-sell value. Therefore, Sam should construct his storage facility that would maximize his re-sell value.