Differential Analysis Involving Opportunity Costs Required: 1. Prepare a differe

Question

Differential Analysis Involving Opportunity Costs

Required:

1. Prepare a differential analysis as of August 1, 2012, 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".

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1. Prepare a differential analysis as of August 1, 2012, 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 or Invest in Bonds August 1, 2012 Operate Invest Differential Effect Retail Store in Bonds on Income (Alternative 1) (Alternative 2) (Alternative 2) Revenues          Costs: Costs to operate retail store          Cost of equipment less residual value          Income (loss)          The proposal to operate the retail store should be    Estimated Income from Operations Total estimated revenue from operating store    Total estimated expenses to operate store: Cost to operate store, excluding depreciation    Cost of store equipment less residual value       Total estimated income from operating store   

Explanation / Answer

A) Let's first find out the net income if we operate the store :

Revenue:

Yearly ( 1 to 8 yrs) (75000*8) 600,000

Yearly ( 9 to 16 yrs) (70000*8) 560,000

Cost :

1. Cost of equipment $ 150,000

Less : Depreciation

( $150,000-$18000=$132000/16=8250p.a) ( $ 132000) (18000)

2. Cost to operate store ($56000×16 years) (896000)

Net income (loss) 246,000

If we operate the store then we will have net income of $ 246,000

B) if we invest in treasury bond

Interest = Principal × interest rate × no of years = 150000×0.06×16 = $144,000

Actual amount we will receive after 16 years = Principal + Interest = $150,000 + $144,000 = $294,000

Hence net gain by investing g in bond is $ 294,000

Differential Gain will be $ 48000 ($ 294,000 - $ 246,000) hence to invest in treasury bond will be more beneficial then to operate the store by buying equipment.

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