Differential Analysis Involving Opportunity Costs On August 1, Midway Distributi

Question

Differential Analysis Involving Opportunity Costs

On August 1, Midway Distribution Company 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 $151,900 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: Prepare a differential analysis as of August 1, 2014, 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". Based on the results disclosed by the differential analysis, should the proposal to operate a retail store be accepted? If the proposal is accepted, what would be the total estimated income from operations of the store for the 16 years?

Explanation / Answer

Solution:

1) Preparation of Differential Analysis:

2) Based on the results disclosed by the differential analysis, should the proposal to operate a retail store be accepted?

No. Based on the results disclosed by the differential analysis, the proposal to operate a retail store should not be accepted because the differential effect on income gives negative results.

3) Calculation of total estimated income from operations of the retail store, if the proposal is accepted:

The $128,600 income from operations could also be determined by adding the $(17,224) loss from operating the retail store as derived in part (1) to the $145,824 of investment income forgone by electing to operate the warehouse.

Differential Analysis Operate Retail Store or Invest in Bonds August 1, 2014 Operate Retail Store Invest in Bonds Differential effect on income Revenues                        1,160,800                 145,824                                           1,014,976 Costs: Costs to operate store                            897,600 0                                              897,600 Cost of equipment less residual value                            134,600 0                                              134,600 Income/(Loss)                            128,600                 145,824                                              (17,224)

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