12. Proper Cash Flows. Conference Services Inc. has leased a large office building for $4 million per year. The building is larger than the company needs; two of the building's eight stories are almost empty. A manager wants to expand one of her projects, but this will require using one of the empty floors. In calculating the net present value of the proposed expansion, senior manage- ment allocates one-eighth of $4 million of building rental costs (i.e., $.5 million) to the project expansion, reasoning that the project will use one-eighth of the building's capacity. (LOI)

a. Is this a reasonable procedure for purposes of calculating NPV?

b. Can you suggest a better way to assess a cost of the office space used by the project?