On October 1, White Way Stores Inc. is considering leasing a building and purcha

Question

On October 1, White Way 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 $180,000 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 $180,000 Life of store equipment 16 years Estimated residual value of store equipment $15,000 Yearly costs to operate the store, excluding depreciation of store equipment $58,000 Yearly expected revenues—years 1–8 $85,000 Yearly expected revenues—years 9–16 $73,000 Required: A. Prepare a differential analysis as of October 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). Refer to the lists of Labels and Amount Descriptions for the exact wording of the answer choices for text entries. For those boxes in which you must enter subtracted or negative numbers use a minus sign. If there is no amount or an amount is zero, enter "0". A colon (:) will automatically appear if required. B. Based on the results disclosed by the differential analysis, should the proposal be accepted? C. If the proposal is accepted, what would be the total estimated income from operations of the store for the 16 years?

Explanation / Answer

a) Alternative 1 : The proposed operation of the store for the 16 years Particulars Amount$ Expected revenues Year 1-8   ( 85000 * 8) a $         6,80,000 Year 9-16 ( 73000 * 8) b $         5,84,000 Total revenue (a+b) c $       12,64,000 Expenses Depreciation over 16 years d $         1,65,000 (180000 - 15000) Costs to operate the store e $         9,28,000 (58000 * 16) Total Expense ( d+e) f $       10,93,000 Net Income    (c-f) g $         1,71,000 Alternative 2 : investing in us treasury bonds Particulars Amount$ Investment in US Treasury bonds a $         1,80,000 Interest rate per annum b 0.06 Interest per annum (a*b) c $             10,800 No of years d 16 Total income from US Treasury bonds (c*d) e $         1,72,800 Differential analysis Particulars Amount$ Alternative 1 Total income from leasing building and purchasing equipment to operate retail store for 16 years a $         1,71,000 Alternative 2 Total income from investment in US Treasury bonds for 16 years b $         1,72,800 Total incremental revenue from leasing building and purchasing equipment to operate retail store (a-b) $             -1,800 b) As per analysis done in differential analysis, Proposal to lease building and purchase equipment to operate retail store for 16 years should not be accepted as it reveals incremental revenue loss of $1800 compared to investment in US Treasury bonds for 16 years. c) If the proposal is accepted, the total estimated income from operations of the store for the 16 years will be $ 171000 (see Answer 1 : Alternative 1 calculation).

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