Question

Differential Analysis Involving Opportunity Costs

On August 1, Rantoul Stores Inc. is considering leasing a building and purchasing the necessary equipment to operate a retail store. Alternatively, the company could use the funds to invest in $1,000,000 of 4% U.S. Treasury bonds that mature in 15 years. The bonds could be purchased at face value. The following data have been assembled:

Cost of store equipment		$1,000,000
Life of store equipment		15 years
Estimated residual value of store equipment		$50,000
Yearly costs to operate the store, excluding
	depreciation of store equipment	$200,000
Yearly expected revenues—years 1–6		$300,000
Yearly expected revenues—years 7–15		$400,000

Required:

1. Prepare a differential analysis as of August 1 presenting the proposed operation of the store for the 15 years (Alternative 1) as compared with investing in U.S. Treasury bonds (Alternative 2). If an amount is zero, enter "0".

Differential Analysis
Operate Retail (Alt. 1) or Invest in Bonds (Alt. 2)
August 1
	Operate Retail (Alternative 1)	Invest in Bonds (Alternative 2)	Differential Effects (Alternative 2)
Revenues	$	$	$
Costs:
Costs to operate store
Cost of equipment less residual value
Profit (loss)	$	$	$

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Subtract the operate costs (15 years) and the cost of the equipment less the residual value from the revenues from operating the operate. Determine the bond investment interest income for 15 years (principal × rate × time). Determine the differential effect on income of the revenues, costs, and profit (loss) by subtracting alternative 2 from alternative 1. Which alternative has the most desirable effect on income?

2. Based on the results disclosed by the differential analysis, should the proposal be accepted?
Yes

3. If the proposal is accepted, what would be the total estimated operating income of the store for the 15 years?

$

Feedback

Subtract the operate costs (15 years) and the cost of the equipment less the residual value from the revenues from operating the operate. Determine the bond investment interest income for 15 years (principal × rate × time). Determine the differential effect on income of the revenues, costs, and profit (loss) by subtracting alternative 2 from alternative 1. Which alternative has the most desirable effect on income?

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Answer 1

Solution 1:

Differential Analysis - Rantoul Stores Inc.
Operate Retail (Alt 1) or Invest in Bonds (Alt2)
Particulars	Operate Retail (alt 1)	Invest in Bonds (alt 2)	Differential effect on income (Alt 2)
	Amount	Amount
Revenues	$5,400,000.00	$600,000.00	-$4,800,000.00
Costs:
Costs to operate warehouse	$3,000,000.00	$0.00	-$3,000,000.00
Cost of equipment less residual value	$950,000.00	$0.00	-$950,000.00
Income / (Loss)	$1,450,000.00	$600,000.00	-$850,000.00

Solution 2:

Yes, proposal to operate retail store should be accepted.

Solution 3:

If the proposal is accepted, total estimated operating income of the store for the 15 years = $1,450,000