Managerial Challenge At US Airways American Airlines Owns A

Managerial Challengeus Airways American Airlines Owns A Piece Of Lan

US Airways owns a piece of land near the Pittsburgh International Airport. The land originally cost the airline $375,000. The company is considering building a new training center on this land. The proposal to build the training center is deemed acceptable if the original cost of the land is used in the financial analysis. However, if the land’s value is considered above $850,000, the proposal does not meet the airline’s project acceptance criteria. The total labor and raw materials for the project are estimated at $1,720,000. Recently, a developer offered US Airways $2.5 million for the land. The task is to determine the economic profit, opportunity cost, and whether US Airways should proceed with building the training center at this location, based on the given data and the concepts of economic cost.

Paper For Above instruction

US Airways’ decision regarding the development of a new training center involves a nuanced understanding of economic principles, particularly the concepts of opportunity cost and economic profit. By analyzing these factors, the airline can make an informed choice that aligns with its financial interests and strategic goals.

Introduction

The decision to invest in infrastructure, such as a training center, requires evaluating the potential costs and benefits, including those not immediately apparent on financial statements. Traditional accounting approaches consider explicit costs, such as labor and raw materials, but do not account for implicit costs like the opportunity cost of land. The case of US Airways owning land near Pittsburgh International Airport illustrates this point, with the added complication of a recent buyout offer from a developer. Examining this scenario through the lens of economic cost and opportunity cost provides clarity on the most beneficial course of action.

Understanding Opportunity Cost

Opportunity cost represents the value of the next best alternative foregone when a decision is made. In this case, US Airways owns land that could be used for constructing a training center, or it could be sold to the developer for $2.5 million. The key question revolves around comparing these options and their associated costs and benefits.

The original cost of the land, $375,000, is a sunk cost and should not influence future decision-making directly. Instead, the relevant economic decision considers the potential sale value of $2.5 million versus the benefits of constructing the training center. If the airline proceeds with the training center, the opportunity cost of using the land is the foregone sale revenue of $2.5 million.

Calculating Economic Profit

Economic profit differs from accounting profit by considering opportunity costs. It is calculated as total revenue minus total costs, including both explicit and implicit costs.

Assuming US Airways builds the training center, the relevant costs are the labor and raw materials ($1,720,000) and the opportunity cost of the land, which is the higher between its current book value and the possible sale value.

In this case, since the land could generate $2.5 million from a sale, the opportunity cost of using the land for the training center is $2.5 million.

The total explicit costs are $1,720,000. The implicit cost is $2.5 million. Therefore, the total cost of building the training center, considering opportunity cost, is $1,720,000 + $2.5 million = $4,220,000.

Evaluating the Proposal Using Financial Criteria

US Airways’ project accepts the proposal if the land's value is at or below $850,000. Since the land's current fair value is $2.5 million (based on the developer's offer), the opportunity cost exceeds the company's threshold for acceptance. This indicates that, economically, the airline foregoes a higher value by building on the land, making the project less favorable unless other strategic benefits outweigh this cost.

Furthermore, the explicit costs sum to $1,720,000, and the opportunity cost of $2.5 million suggests that building the training center would result in an economic loss, as the total costs ($4,220,000) surpass the benefits of owning or selling the land.

Should US Airways Build the Training Center?

Considering the financial and strategic implications, US Airways should evaluate whether the benefits of the new training facility justify the high opportunity cost associated with the land. Since the land could be sold for $2.5 million, and the project's costs significantly exceed the threshold value of $850,000, the opportunity cost indicates that the airline would be sacrificing considerable value by proceeding with the construction.

Unless there are compelling strategic reasons—such as long-term brand value, operational efficiencies, or other intangible benefits—that could justify the expenditure, the optimal decision based purely on economic principles would be to sell the land and avoid incurring further costs on a project that does not meet the airline’s acceptance criteria.

Therefore, from an economic perspective, US Airways should consider selling the land at the offered price of $2.5 million. This action would maximize economic profit and minimize opportunity costs, aligning with rational decision-making strategies in corporate finance.

Conclusion

In conclusion, the analysis underscores the importance of considering opportunity costs in managerial decisions. The potential sale of the land at $2.5 million presents a more economically favorable alternative compared to constructing the training center on land valued at over $850,000. US Airways should prioritize opportunities that maximize value and align with its strategic objectives, which, in this scenario, suggests selling the land rather than building on it.

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