Question

Five Star is considering leasing a building and buying the necessary equipment to operate a public warehouse. Alternatively, the company could use the funds to invest in $149,700 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 equipment $149,700 Life of equipment 16 years Estimated residual value of equipment $27,600 Yearly costs to operate the warehouse, excluding depreciation of equipment $56,200 Yearly expected revenues—years 1-8 84,900 Yearly expected revenues—years 9-16 72,100 Required: Question Content Area 1. Prepare a differential analysis report of the proposed operation of the warehouse for the 16 years as compared with present conditions. Five Star Proposal to Operate Warehouse blank Differential revenue from alternatives: $ Revenue from operating warehouse Revenue from investment in bonds $ Differential revenue from operating warehouse Differential cost of alternatives: $ Costs to operate warehouse Cost of equipment less residual value Differential cost of operating warehouse $ Differential income from operating warehouse Feedback Area Feedback 1. Follow Exhibit 2 and Exhibit 9 in the text. Subtract the warehouse operating costs (16 years) and the cost of the equipment less residual value from the revenues from operating the warehouse. Determine the bond investment interest income for 16 years (principal x rate x time). Determine the differential effect on the revenues, costs, and income (loss). Question Content Area 2. Based on the results disclosed by the differential analysis, should the proposal be accepted? 3. If the proposal is accepted, what is the total estimated operating income of the warehouse for the 16 years? $ fill in the blank 442d77fcbfd2032_2

Answer 1

1. Differential revenue from operating the warehouse: $1,112,468

2. The proposal should be accepted.

3. Total estimated operating income of the warehouse for 16 years: $234,700.

Explanation:

Question Content Area 1:

Differential revenue from alternatives:

Revenue from operating warehouse:

Years 1-8: $84,900 x 8 = $679,200

Years 9-16: $72,100 x 8 = $576,800

Total revenue = $679,200 + $576,800 = $1,256,000

Revenue from investment in bonds:

Principal = $149,700

Rate = 6%

Time = 16 years

Interest income = $149,700 x 0.06 x 16 = $143,532

Differential revenue from operating warehouse:

$1,256,000 - $143,532 = $1,112,468

Differential cost of alternatives:

Costs to operate warehouse:

Yearly costs = $56,200 x 16 = $899,200

Cost of equipment less residual value:

$149,700 - $27,600 = $122,100

Differential cost of operating warehouse:

$899,200 + $122,100 = $1,021,300

Differential income from operating warehouse:

$1,112,468 - $1,021,300 = $91,168

Question Content Area 2:

Based on the results disclosed by the differential analysis, the proposal should be accepted as it generates a positive differential income of $91,168 over the 16 years compared to the alternative investment in U.S. Treasury bonds.

Question Content Area 3:

If the proposal is accepted, the total estimated operating income of the warehouse for the 16 years would be:

Total revenue - Costs to operate warehouse - Cost of equipment less residual value

$1,256,000 - $899,200 - $122,100 = $234,700

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