Which base to close, relevant-cost analysis, opportunity costs? The U.S. Defense Department has the difficult decision of deciding which military bases to shut down. Military and political factors obviously matter, but cost savings are also an important factor. Consider two naval bases located on the West Coast— one in Alameda, California, and the other in Everett, Washington. The Navy has decided that it needs only one of those two bases permanently, so one must be shut down. The decision regarding which base to shut down will be made on cost considerations alone. The following information is available:

a. The Alameda base was built at a cost of $100 million. The operating costs of the base are $400 million per year. The base is built on land owned by the Navy, so the Navy pays nothing for the use of the property. If the base is closed, the land will be sold to developers for $500 million.

b. The Everett base was built at a cost of $150 million on land leased by the Navy from private citizens. The Navy can choose to lease the land permanently for a lease payment of $3 million per year. If it decides to keep the Everett base open, the Navy plans to invest $60 million in a fixed income note, which at 5% interest will earn the $3 million the government needs for the lease payments. The land and buildings will immediately revert back to the owner if the base is closed. The operating costs of the base, excluding lease payments, are $300 million per year.

c. If the Alameda base is shut down, the Navy will have to transfer some personnel to the Everett facility. As a result, the yearly operating costs at Everett will increase by $100 million per year. If the Everett facility is closed down, no extra costs will be incurred to operate the Alameda facility.

The California delegation in Congress argues that it is cheaper to shut down the Everett base for two reasons: (1) it would save $100 million per year in additional costs required to operate the Everett base, and (2) it would save the lease payment of $3 million per year. (Recall that the Alameda base requires no cash payments for use of the land because the land is owned by the Navy.) Do you agree with the California delegation’s arguments and conclusions? In your answer, identify and explain all costs that you consider relevant and all costs that you consider irrelevant for the base-closing decision.