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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
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?

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

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

b)

To determine

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

c)

To determine

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

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