Differential Analysis Involving Opportunity Costs On July 1, Midway Distribution

Question

Differential Analysis Involving Opportunity Costs On July 1, Midway Distribution Company i s considering leasing a building and buying the necessary equipment to operate a public warehouse. Alternatively, the company could use the funds to invest in $150,500 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 Life of store equipment Estimated residual value of store equipment Yearly costs to operate the warehouse, excluding depreciation of equipment $150,500 16 years $18,500 depreciation of store equipment Yearly expeted revenues-years 1-8 Yearly Required: $55,200 74,100 70,600 s 9-16 for the 16 years (Alternative 1) as compared with investing in U.S. Treasury bonds (Alternative 2). If an amount is zero, enter "o". 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

Explanation / Answer

1) Differential Analysis:-

2) No , as investment in bonds provides higher income than Operating Public Warehouse.

3) Estimated Income from operation of warehouse = $142400

Particulars Operate Public Warehouse Invest in bonds Differential effect on Income Revenue (($74100*8)+($70600*8)) = $1157600 ($150500*6%*16) = $144480 $1013120 Less : Cost :- Cost to Operate Warehouse ($55200*16) = $883200 $0 $883200 Cost of Equipment less residual value ($150500 - $18500) = $132000 $0 $132000 Income / (Loss) $142400 $144480 $2080

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