Question

PART TWO:

A few weeks back a friend of Barry, Ray Sellsit a local realtor mentioned that a larger manufacturing facility in nearby Kingsville is available for long-term lease. The facility is larger but Barry estimates that the utility costs will be lower because it is more modern and energy efficient. Potential benefits to this new facility will that WCI will not have to pay property taxes or building insurance since it will not own the building. The lease would be considered and operating lease, so it can be fully expensed. Due to the size of

the facility, it is estimated by Barry they could sublet 20% of the facility for the next five years until it can take over the whole facility.

Ray believes that selling the existing facility in Harrow should not be a problem, who he has a few clients that may want the facility. The current facility is not fully depreciated and Barry believe it could help the bottom line as depreciation expense will not be charged. A possible other benefit of selling the existing facility is that WCI will no longer incur repair and maintenance costs, or the salary of a building maintenance manager, who would be terminated if they decide to lease this new building. All maintenance costs will be paid by the owner, unless the repairs are the result of damage caused by WCI in which the costs would be responsible for those costs. The insurance on the inventory, equipment and security will not change if WCI decides to move to the new warehouse.

One potential drawback is if the sell the existing facility, WCI will no longer earn operating income for the parking lot, which WCI rented to an adjacent company. The company made a small profit each year after all expenses associated with the parking lot.

Required:

1. Identify the differential revenues and costs related to keeping the existing facility in Harrow versus renting the new facility in Kingsville.
2. Are there any opportunity costs associated with selling the old facility?
3. What kind of cost is the depreciation expense on the old facility? Should it be considered in deciding whether to stay in the existing building or rent the new facility? Why or why not?

Answer 1

Following are the differential revenue and cost related to keeping the existing facility in harrow versus renting the new facility in Kingsville:-

	Old facility harrow owned	New facility at Kingsville on lease
Property tax	yes	no	differential cost
Building insurance	yes	no	differential cost
Lease exp	no	yes	differential cost
Sublet revenue	no	yes	differential revenue
Depreciation exp	yes	no	differential cost (absorption costing)
Repair and maintenance	yes	no	differential cost
Building maintenance manager	yes	no	differential cost
Insurance on inventory	yes	yes	sunck cost
Insurance on equipment	yes	yes	sunk cost
Security	yes	yes	sunk cost
Revenue from peaking	yes	no	Opportunity cost

(B) . Yes, there is an opportunity cost associated with selling the old facility. If we sell the old facility then we will not be able to earn profit that we are earning the giving the space available in old facility for parking. Thus, profit arising from giving space for parking is an opportunity cost related to selling their facility.

(C). Depreciation expense is a fixed sunk cost if we think from a decision-making point of view and hence it should not be considered I'm deciding whether to stay in the existing building or rent the new facility since in real terms we do not have to incur any expense under the head depreciation. It is arising only as a result of past expenses that we have incurred in buying the old facility.