Accounting Ii P12-1

On March 1, Midway Distribution Company 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 $750,000 of 7% U.S.

Treasury bonds that mature in 14 years. The bonds could be purchased at face value. The following data have been assembled:

Cost of equipment ………………….….. $750,000

Life of equipment …………………….… 14 years

Estimated residual value of equipment … $76,000

Yearly costs to operate the warehouse,

excluding depreciation of equipment ….. $195,000

Yearly expected revenues—years 1–7 …. $330,000

Yearly expected revenues—years 8–14 … $280,000

Instructions

1. Prepare a report as of March 1, 2010, presenting a differential analysis of the proposed operation of the warehouse for the 14 years as compared with present conditions.

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 income from operations of the warehouse for the 14 years?

SOLUTION

1.

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1 (7 yrs. × $330,000) + (7 yrs. × $280,000)

2 7% × $750,000 × 14 yrs.

3 $195,000 × 14 yrs.

2. The proposal should be accepted.

3. Total estimated revenue from operating

warehouse.................................................................. $4,270,000

Total estimated expenses to operate warehouse:

Costs to operate warehouse, excluding

depreciation ............................................................ $ 2,730,000

Cost of equipment less residual value ..................... 674,000 3,404,000

Total estimated income from operating

warehouse.................................................................. $ 866,000*

*The $866,000 income from operations could also be determined by adding the $131,000 income from operating the warehouse as derived in part (1) to the $735,000 of...