On July 1, Coastal Distribution Company is considering leasing a building and bu

Question

On July 1, Coastal 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 $ 740,000 of 5% U.S. Treasury bonds that mature in 14 years. The bonds could be purchased at face value. The following data have been assembled:
Cost of equipment ................ $ 740,000
Life of equipment ................ 14 years
Estimated residual value of equipment ........ $ 75,000
Yearly costs to operate the warehouse, excluding
depreciation of equipment ............. $ 175,000
Yearly expected revenues __years 1- 7 ....... $ 280,000
Yearly expected revenues__years 8- 14 ....... $ 240,000

Instructions
1. Prepare a differential analysis as of July 1, 2014, presenting the proposed operation of the warehouse for the 14 years (Alternative 1) as compared with investing in U. S. Treasury bonds (Alternative 2).
2. Based on the results disclosed by the differential analysis, should the proposal be accepted?
3. If the proposal is accepted, what is the total estimated income from operations of the warehouse for the 14 years?

Explanation / Answer

1. Differential Analysis:

For the next 7 Years:

Differential Analysis:

Total Inflow from Warehouse in 14 Years = 402,500 + 197,500 = $600,000

Total Inflow from Treasury Bond = 259,000 + 259,000 = $518,000

2. The proposal of warehouse should be accepted because its cash inflow is more than treasury bonds.

3. The Total income for warehouse = $600,000.

Equipment Treasury Bond Annual Revenue 280,000 37,000 Less: Yearly Cost 175,000 Less: Depreciation 47,500 Annual Inflow 57,500 Total for 7 Years 402,500 259,000

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