Question

Differential Analysis Involving Opportunity Costs

On July 1, Midway Distribution Company 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 $148,200 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 store equipment		$148,200
Life of store equipment		16 years
Estimated residual value of store equipment		$17,400
Yearly costs to operate the warehouse, excluding depreciation of equipment
	depreciation of store equipment	$56,200
Yearly expected revenues—years 1-8		76,000
Yearly expected revenues—years 9-16		70,200

Required:

1. Prepare a differential analysis as of July 1 presenting the proposed operation of the warehouse for the 16 years (Alternative 1) as compared with investing in U.S. Treasury bonds (Alternative 2). If an amount is zero, enter "0". For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Differential Analysis
Operate Warehouse (Alt. 1) or Invest in Bonds (Alt. 2)
July 1
	Operate Warehouse (Alternative 1)	Invest in Bonds (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues	$	$	$
Costs:
Costs to operate warehouse
Cost of equipment less residual value
Income (Loss)	$	$	$

2. Based on the results disclosed by the differential analysis, should the proposal to operate a retail store be accepted?
No

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

Answer 1

11 12 Ques 1 13 Differential Analysis 14 Operate Warehouse (Alt. 1) or Invest in Bonds (Alt. 2) 15 Jul-01 16 Operate Warehouse (Alternative 1 Invest in Bonds (Alternative 2 Differential Effect on Income (Alternative 2) 17 1169600 1027328 18 Revenues 142272 (148200 6 % 16) (76000 8+70200 8) 19 20 Costs: 21 Costs to operate warehouse 899200 899200 (56200 16) 22 130800 23 Cost of equipment less residual value 130800 (148200-17400) 24 25 Income (Loss) 139600 142272 -2672 26 27 Ques 2 28 the proposal should not be accepted 29 30 Ques 3 31 total estimated revenue from operating ware house 1169600 32 Lesstotal estimated expenses 33 Costs to operate warehouse 899200 1030000 34 Cost of equipment less residual value 130800 35 total estimated income from operating warehouse 139600 36