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Question & Answer: On October 1, White Way Stores Inc. is considering leasing a building and purchasing the necessary equipment to operate a retail store. Alternatively, t…..

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 Life of store equipment Estimated residual value of store equipment Yearly costs to operate the store, excluding $180,000 16 years $15,000 depreciation of store equipment Yearly expected revenues -years 1-8 Yearly expected revenues-years 9-16 $58,000 $85,000 $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). accepted? of the store for the 16 years? 2. Based on the results disclosed by the differential analysis, should the proposal be 3· If the proposal is accepted, what would be the total estimated income from operations

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: 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). Based on the results disclosed by the differential analysis, should the proposal be accepted? If the proposal is accepted, what would be the total estimated income from operations of the store for the 16 years?

Expert Answer

 

1.

Operate Store (Alternative One) Invest in Bonds (Alternative 2) Differential Effect (Alternative 2)
Revenues 1264000 172800 -1091200
Costs:
Cost to operate retail store 928000 0 -928000
Cost of equipment less residual value 165000 0 -165000
Income (Loss) 171000 172800 1800

Formulas:

Operate Store (Alternative One) Invest in Bonds (Alternative 2) Differential Effect (Alternative 2)
Revenues =85000*8+73000*8 =180000*0.06*16 =C2-B2
Costs:
Cost to operate retail store =58000*16 0 =C4-B4
Cost of equipment less residual value =180000-15000 0 =C5-B5
Income (Loss) =B2-B4-B5 =C2-C4-C5 =D2-D4-D5

2. The proposal to operate the retail store should be rejected as the income from bonds is more.

3.

Operate Store
Total estimated revenue from operating store 1264000
Total estimated expenses to operate store
Cost to operate retail store 928000
Cost of equipment less residual value 165000
Total estimated income from operating store 171000
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