Question

Differential Analysis Involving Opportunity Costs

On August 1, Matrix 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 $149,900 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		$149,900
Life of store equipment		16 years
Estimated residual value of store equipment		$18,700
Yearly costs to operate the store, excluding
	depreciation of store equipment	$56,800
Yearly expected revenues—years 1-8		75,500
Yearly expected revenues—years 9-16		70,600

Required:

1. Prepare a differential analysis as of August 1 presenting the proposed operation of the store for the 16 years (Alternative 1) as compared with investing in U.S. Treasury bonds (Alternative 2). If an amount is zero, enter zero "0".

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

Answer 1

Differential Analysis
Operate Retail Store (Alt. 1) or Invest in Bonds (Alt. 2)
August 1
	Operate Retail Store (Alternative 1)	Invest in Bonds (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues	1168800	143904	-1024896
Costs:
Cost to operate store	908800	0	908800
Cost of equipment less residual value	131200	0	131200
Income (Loss)	128800	143904	15104

Working:

Operate Retail Store = ($75500 x 8) + ($70600 x 8) = $604000 + $564800 = $1168800

Invest in Bonds = $149900 x 6% x 16 = $143904

Costs to operate store = $56800 x 16 = $908800

Cost of equipment less residual value = $149900 - $18700 = $131200