323.12
12.You're doing a capital budgeting problem and you note that the
market value of any land currently owned by the company that is
used by the new project is a cost, but allocation of current
overhead is not. Your boss challenges your analysis. Explain why
you're right. (6)
In class, we called these two things opportunity costs and allocated overhead (sunk or non-incremental). Employing anything that the company already owns in a new project means that you can’t employ it in anything else. Specifically, if you use a parcel of land in the project, you can’t sell it. Thus, you are giving up the market value of the land by using it for the project. You are essentially buying the land from yourself since you could have sold it instead of taking the project. Conversely, current overhead should not be allocated to a new project. Again, looking at it simply through "with vs. without" analysis, you would (and do) have current overhead even without the project, so by not taking the project, you are NOT saving any part of current overhead. Similarly, by taking the project, you are not causing the company to incur CURRENT overhead, so the current overhead would be there with or without the project and should not be charged off to the project.