Question

Differential Analysis Report Involving Opportunity Costs

Five Star is considering leasing a building and buying the necessary equipment to operate a public warehouse. Alternatively, the company could use the funds to invest in $149,400 of 6% U.S. Treasury bonds that mature in 16 years. The bonds could be purchased at face value. The following data have been assembled:

Cost of equipment		$149,400
Life of equipment		16 years
Estimated residual value of equipment		$27,200
Yearly costs to operate the warehouse, excluding
	depreciation of equipment	$56,200
Yearly expected revenues—years 1-8		85,200
Yearly expected revenues—years 9-16		72,900

Required:

1. Prepare a differential analysis report of the proposed operation of the warehouse for the 16 years as compared with present conditions.

Five Star
Proposal to Operate Warehouse
Differential revenue from alternatives:
	$
		$
Differential cost of alternatives:
	$
		$

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

3. If the proposal is accepted, what is the total estimated operating income of the warehouse for the 16 years?
$

Answer 1

Five Star
Proposal to Operate Warehouse
	Amount	Amount
Differential Revenue From Alternatives: (A)
Revenue From Operating Warehouse (8 year X 85200)+(8yearX 72900)	$1,264,800
Revenue From Investment In Bonds (149400*6%*16)	$143,424
Differential Revenue From Operating Warehouse		$1,408,224
Differential Cost Of Alternatives: (B)
Costs To Operate Warehouse (56200*16)	$899,200
Cost Of Equipment Less Residual Value (149400-27200)	$122,200
Differential Cost Of Operating Warehouse		$1,021,400
Differential Income From Operating Warehouse (A-B)		$386,824

Yes Proposal should be accpted

Computation of total income from Operation
	Amount	Amount
Estimated Revenue From Operating Warehouse		$1,264,800
Less: Estimated Expenses To Operate Warehouse:
Costs To Operate Warehouse, Excluding Depreciation	$899,200
Cost Of Warehouse Equipment Less Residual Value	$122,200	$777,000
Estimated Income From Operating Warehouse		$487,800