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Differential analysis involving opportunity costs 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 Instructions 1. 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). 2. Based on the results disclosed by the differential analysis, should the proposal be accepted? 3. If the proposal is accepted, what would be the total estimated income from operations of the store for the 16 years?

BuyFind

Accounting

27th Edition
WARREN + 5 others
Publisher: Cengage Learning,
ISBN: 9781337272094
BuyFind

Accounting

27th Edition
WARREN + 5 others
Publisher: Cengage Learning,
ISBN: 9781337272094

Solutions

Chapter
Section
Chapter 25, Problem 25.1APR
Textbook Problem

Differential analysis involving opportunity costs

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

Instructions

1.    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).

2.    Based on the results disclosed by the differential analysis, should the proposal be accepted?

3.    If the proposal is accepted, what would be the total estimated income from operations of the store for the 16 years?

Expert Solution

a)

To determine

Opportunity Cost: Opportunity cost refers to the forgone revenue which could have been generated through an alternative use of the assets.

Differential Analysis: Differential analysis refers to the analysis of differential revenue that could be gained or differential cost that could be incurred from the available alternative options of business

To Prepare: The differential analysis of Company WWS as on October 1, for given alternatives.

Explanation of Solution

The differential analysis of Company WWS as on October 1, for given alternatives is shown below.

Differential Analysis of Company WWS
Operate Retail Store  (Alt. 1) or Invest in Bonds (Alt. 2)
October 1
Operate Retail Store     (Alternative 1) Invest in Bonds  (Alternative 2) Differential effect on income
Revenues (1)   $1,264,000 (2)   $172,800 (-)  $1,091,200
Costs
   Cost to operate the store (3)  (-)  $928,000 $0 $928,000

   Cost of equipment less                

   residual value

(4)  (-)  $165,000 $0 $165,000
Income (loss) $171,000 $172,800 $1,800

Table (1)

Differential analysis of Company WWS as on October 1, shows that the investment in bonds yeilds a greater income of $1,800 over the period of 16 years than operating a store.

Working Notes:

Calculate the revenues from operating the store for 16 years.

Revenues fromoperating the store}=($85,000×8)+($73,000×8)=$680,000+$584,000=$1,264,000

(1)

Calculate the revenues from investing in bonds for 16 years

Expert Solution

b)

To determine

To Deicide: The proposal to be accepted on the basis of differential analysis.

Expert Solution

c)

To determine

To Calculate: The total estimated income from the operation of store for 16years.

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Chapter 25 Solutions

Accounting
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