What should US Airways do in the following situation?
US Airways owns a piece of land near the Pittsburgh International Airport. The land originally cost US Airways $375,000. The airline is considering building a new training center on this land. US Airways determined that the proposal the new facility is acceptable if the original cost of the land is used in the analysis, but the proposal does not meet the airline’s project acceptance criteria if the land cost is above $850,000. A developer recently offered US Airways $2.5 million for the land. Should US Airways build the training facility at this location?
If one assumption that I have is correct, then US Airways should not build the training facility at this location. The reason for this is that the company should use the current value of the land and not the original cost in its decision-making process.
The one assumption here is that the company has factored in the cost of buying land somewhere else to build the training facility. If this has been done, then the airline should not build in Pittsburgh.
The reason for this has to do with the concept of implicit costs. If the airline were to build in Pittsburgh, its implicit cost would be well over $850,000. Its implicit cost would be $2.5 million because that is how much it would be giving up (in foregone revenue from the sale) in order to be able to build the training center. When conducting a cost analysis, the firm must pay attention to the amount of money that they are giving up (implicit costs) not just to the amounts that they are spending (explicit costs).