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: DITUTUL 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 Yearly expected revenues-Years 1-6 Yearly expected revenues-years 7-15 $200,000 $300,000 $400,000 Required:

Answer 1

Total revenue from store equipment = 300,000 x 6 + 400,000 x 9

= 1,800,000+3,600,000

= $5,400,000

Total revenue from bonds = 1,000,000 x 4% x 15

= %600,000

Total costs to operate store = 200,000 x 15

= $3,000,000

Cost of Equipment loss residual value = 1,000,000 - 50,000

= $950,000

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	5,400,000	600,000	-4,800,000
Costs:
Cost of operate store	3,000,000	0	3,000,000
Cost of equipment less residual value	950,000	0	950,000
Profit	$1,450,000	$600,000	-$850,000

3.

Total estimated operating income of the store for 15 years = $1,450,000

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