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Chapter 24 PR 24-1B

PR.24-01B.ALGO

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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 $150,300 of 5% 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		$150,300
Life of store equipment		16 years
Estimated residual value of store equipment		$17,200
Yearly costs to operate the warehouse, excluding depreciation of equipment
	depreciation of store equipment	$56,800
Yearly expected revenues—years 1-8		75,300
Yearly expected revenues—years 9-16		69,600

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)	$	$	$

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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

Solution 1:

Differential Analysis
Operate Warehouse (Alt 1) or Invest in Bonds (Alt2)
Particulars	Operate Warehouse (alt 1)	Invest in Bonds (alt 2)	Differential effect on income (Alt 2)
	Amount	Amount
Revenues	$1,159,200.00	$120,240.00	-$1,038,960.00
Costs:
Costs to operate warehouse	$908,800.00	$0.00	-$908,800.00
Cost of equipment less residual value	$133,100.00	$0.00	-$133,100.00
Income / (Loss)	$117,300.00	$120,240.00	$2,940.00

Solution 2:

As there is addtional income of $2,940 on investing in treasury bonds therefore proposal to operate a retail store should not be accepted.

Solution 3:

If proposal is accepted then total estimated income from operations of the warehouse for 16 years = $117,300.